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Maximum RRSP contributions yield best chance of adequate retirement income

by Wayne Cheveldayoff, 2004-01-05

Canadians get inundated in the months of January and February each year by mutual fund advertising and calls from investment advisors pushing them to make a Registered Retirement Savings Plan (RRSP) contribution. For the most part, the advice is right.

If you are procrastinating, spending all your money or dreaming of a lottery win instead of contributing to an RRSP, you are likely missing your best chance of having enough income in retirement.

Some may be lucky enough to have a great employer-sponsored pension plan that will provide sufficient inflation-indexed pension income after age 65.

But surveys show most Canadians don’t have adequate employer plans and, furthermore, most aren’t saving enough to leave the workforce at age 60 or 65 when very modest Canada Pension Plan and Old Age Security benefits kick in.

The key advantage of an RRSP is the special tax treatment. All contributions are tax deductible and all earnings within the plan are tax sheltered until withdrawn. March 1 is the deadline for 2003 contributions, which are limited to 18 per cent of income, or a maximum of $14,500.

An RRSP is the main tax shelter available for Canadians who want to save for retirement and it makes sense for most people to make full use of it. (Those over 60 may want to consult a financial planner to make sure.)

Advisors have seen many calculations contrasting the power of saving through an RRSP versus saving outside of one (and therefore paying income taxes on dividends, capital gains and interest income).

The RRSP alternative almost always yields more after-tax income in retirement and this is why advisors champion this route, especially since every little bit of added income will help at that stage of peoples’ lives.

Just consider how a small amount of inflation can upset our present impressions of what income we need to live on. For example, if inflation is 1 per cent a year, someone presently requiring $50,000 a year would need $55,200 a year in 10 years and $61,000 a year in 20 years to maintain the same standard of living. If inflation is 3 per cent a year, he or she would need $67,200 a year in 10 years and $90,300 in 20 years.

Many Canadians in their 20s and 30s make the choice of buying a home instead of contributing all they are allowed into an RRSP. Some take comfort from the fact that RRSP rules allow missed contributions in one year to be carried forward indefinitely, allowing people to catch up later.

But any move to delay making the maximum RRSP contribution—even to buy a home—could well be a mistake for some, especially for those who won’t have an employer-sponsored pension plan and will need to rely on their own savings in retirement.

The following example illustrates how much you can hurt your retirement savings by diverting RRSP money into a house in your early years. Assuming a 7 per cent rate of return, if you contribute $12,000 a year to an RRSP starting at age 35 and then stop contributions 10 years later (putting your money instead into a house), your RRSP will grow to $1,224,876 by age 65. However, if buy a house first and wait until age 45 and then invest $12,000 annually in an RRSP for the next 20 years, you will have only $526,382 at age 65. It’s an enormous difference.

What the example suggests is that if you don’t have the income to both buy a house and contribute to an RRSP in your early years, it is better to contribute to an RRSP for a number of years and then buy the house.

For those already with a house and mortgage, the standard advice from financial planners—that is, make your full RRSP contribution and use the tax refund to pay down the mortgage—may be the best. However, it depends on your circumstances. You can work through different scenarios using a Mortgage vs RRSP Calculator of the kind available at

The best RRSP strategies are not always the obvious ones. For instance, the rules allow a person to borrow up to $20,000 from his or her RRSP ($40,000 for a couple) to buy a home, paying the money back over the next 16 years. But in the case of a family with a stay at home or very low income spouse, now or planned for child-raising in the future, it may be better for the higher-income spouse to contribute to a spousal RRSP plan and then have the spouse make withdrawals from it, which won’t have to be paid back, for a down-payment on the house.

Withdrawals by the spouse from a spousal RRSP are not attributed back to the contributor three years after the contribution. This is an attractive income-splitting technique that is often overlooked.

Many short on cash wonder if they should borrow to contribute the maximum to an RRSP. There is no hard-and-fast rule. The answer depends on your own situation.

Borrowing can make sense if you are temporarily short of cash and can easily spare it in the future to pay back the loan. You need to have a clear and disciplined approach to repayment of the loan. Keep in mind that the interest on RRSP loans is not deductible.

But the best approach by far is to develop a disciplined savings plan from the start so that borrowing is not needed. Use the retirement calculators available on many of the financial web sites to see what a major difference it would make in retirement if you now save even as little as it costs for a coffee and a donut each day.

Also, those wanting to make regular monthly RRSP contributions will be able through their employers to reduce the tax deductions at source, eliminating the need to use after-tax dollars for the contributions and then waiting for the tax refund next year.

If you are having problems with the math or working out a strategy, remember that financial planners and investment advisors are a good resource in managing this part of your financial life. Make use of them.

Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. He can be contacted at

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©2004 Wayne Cheveldayoff