My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. My posts are blunt, opinionated and even have a twist of humour/sarcasm. You've been warned. Please note the blog posts are time sensitive and subject to changes in legislation or law.

Thursday, January 27, 2011

The RRSP Hullabaloo

There has been a sudden surge of angst in the media recently in regard to; whether you should contribute to your RRSP or TFSA, whether the mandatory minimum yearly withdrawals from your RRIF are too high, and finally, how higher tax rates in the future could affect your RRIF at the time of withdrawals.

I just don’t get this angst. High income earners are already contributing to both their RRSP and their TFSA. They are tax neutral at worst in their RRSP’s as they get a refund on their RRSP at the highest marginal rate of 46.41% and currently pay tax on RRIF withdrawals at 46.41%.

Low income earners are not making RRSP contributions, so unfortunately, they are not part of any argument. So, who does this discussion impact? Maybe the lower middle class, the middle class and the upper middle class.

At this point I want to clarify that if your current marginal income tax rate is equal to or higher then your anticipated marginal tax rate at retirement, you can’t be worse off RRSP wise, subject to inflation and increases in the marginal tax rates. I would suggest that for most people, their marginal rate will be lower at retirement.

In response to a blog along those lines by Larry Macdonald (click here to see Larry’s excellent blog), I wrote the following (I have amended this slightly from my response to Larry):

Let’s say Andrea makes between $80,000 to a $120,000 in his peak earning years of 45-65. I would say Andrea is upper middle class with his earnings. During those years he contributes on average $10,000 to his RRSP and let’s say the RRSP grows at 6%. Finally, let’s say that from age 65 until age 71, Andrea and his wife Barbani fund their retirement and Raptor tickets by living off other savings and an inheritance and do not encroach on his RRSP until age 71.

Andrea’s RRSP contributions from age 45-65 would have grown to approximately $350,000 at age 65, give or take a few bucks, and would further grow to $500,000 by age 71 when he has to convert his RRSP to a RRIF. His minimum RRIF withdrawals would be almost $40k or so at 71, dropping down to the lower $30’s as he ages.

Assume Andrea and Barbani’s CPP and OAS is $30k combined (probably typical for a family with a wife who worked, but had some years off to raise the kids).

Thus, the family will have around $70k a year in taxable retirement income. Assuming today’s marginal tax rates and using split pension amounts to share the tax hit, each spouse would pay income tax of around $4,000 or 11% after taking into account the age and pension amounts.

During the years Andrea earns $80k to $120k he saved 40-46% for each RRSP contribution and at retirement he is only paying 11%. For what I would consider not far off the typical Canadian living in a large city, I see no argument against the use of a RRSP. Of course inflation would factor into this calculation. However, the point of the above exercise is to reflect the 30% or so difference in Andrea’s current marginal rate and the low rate he and his wife would incur at retirement.

In regard to the TFSA argument, in the above example, $10,000 contributed to a RRSP nets a refund of approximately $4,600 and the tax on the cash coming out of the RRIF is $1,100 per $10,000 (11% on $10,000). Thus, the net after-tax cash flow is $13,500 ($10,000 original RRSP contribution + $4,600 original refund less $1,100 income tax) far in excess of the $10,000 you could alternatively put in your TFSA. 

The above is obviously very oversimplified to make a point. I did not account for the tax free growth in the RRIF and TFSA and the fact the tax-free growth in the RRSP is taxed and the tax-free growth in the TFSA is not. However, if you put the $4,600 refund from your RRSP into your TFSA, you would still be substantially better off with the RRSP, due to the low rate of income tax upon the withdrawal of your RRIF, even though all the growth of the TFSA is tax-free.  

There are various factors that could change the above results. Tax rates can increase over time, inflation can rear its ugly head  and where one spouse dies, the surviving spouse could get caught up in higher tax rates and the income splitting benefit stops with the passing of the other spouse.

All in all, I just don’t see the cause for angst around this topic. 

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  1. I don't understand the hullabaloo either. And it annoys me no end that people who should know better say things like "well, a RRSP doesn't allow you to take advantage of lower capital gains and dividend rates". They should just set up a spreadsheet and work the numbers. A RRSP is hands down better than taxable accounts for most taxpayers.

  2. Canadian Capitalist- I totally agree and I know you stated that opinion already earlier in the week. I just wanted to attempt to show this through numbers and that for most Canadians, even fairly successful ones, the pension splitting rules will allow them to make RRIF withdrawls at income tax rates far below the rate they obtain their refund on their RRSP contributions.

  3. Mark, if Andrea died in his early seventies, how would that change his wifes tax rate? TIA

  4. Hi Elsie

    There is not a direct comparable, since if Andrea died his OAS & CPP would stop (there would be some survivor pension continue).

    However, to get to what I think you want to understand; lets say the income stays at $70k with $15k of OAS and CPP and $55k of RRIF to keep it comparable. Andrea's wife Barbani would now owe almost $16,000 double what Andrea and Barbani paid as a couple. In addition her OAS would be clawed back slightly. Thus, her combined income tax rate would now be almost 23% of her income.

  5. Upon my father's death there were several RRIF accounts for my mother
    There were spousal and non-spousal RRIF accounts
    I am looking to consolidate the accounts, what is required to covert the spousal RRIFs to non-spousal RRIFs?
    Thanks M

    1. Hi Anon

      Not sure, that is a financial institution thing. I had this once before and the institution just merged the accounts, but you need to speak to the specific institution to find out their policy in regard to spousal and non spousal RRIFs

  6. Mark, do the comparisons take into consideration the income tax refund that an RRSP generates and if so, if the refund is invested? Thanks, Ronnie

    1. no. Also note this discussion is very old, you can find much more recent discussion is you just google the topic