Response to Reader Question #16

In a somewhat unusual fashion I got a comment on this post from a reader, Robert, that basically turned into it’s own post by size alone.  Actually I thought Robert did a good job getting in to a few more details than I did in the original post.  So give it a read and let me know what you think. -Tim

How valuable is the RRSP deduction?

The Registered Retirement Savings Plan (RRSP) is a government program meant to encourage people to save for their retirement. Up to your contribution limit, you receive a tax deduction for contributions you make. For example, if you are in the 32% tax bracket and contribute $1000, you will receive a refund of $320. In retirement, all withdraws are taxable, so if you withdraw $1000, it will be added to your taxable income.

If you will be in a lower tax bracket ( in retirement than your working life, this can work very well. In the example above, suppose you are in the 25% tax bracket in retirement. You invest $1000 and get a refund of $320. The money doubles by retirement, and you withdraw $2000. At 32%, the tax would be $640, but in the 25% tax bracket you only owe $500, a savings of $140.

There are some potential pitfalls with RRSPs. If you are in the same tax bracket or higher in retirement, you will not reduce your tax bill. The taxes will be postponed, but because all withdraws are taxed, your tax bill could represent the same proportion of your account, 32% in the example above. There are a few considerations to keep in mind. First, the government is constantly changing the tax rates and tax brackets. The tax brackets tend to increase with inflation, but recently the basic personal amount has increased from $8,500 to  $10,000 to reduce the amount of tax paid by those who earn the least. On the other hand, tax rates were much higher during the 80s and 90s, and could be increased again. Second, tax rates and tax brackets are different among provinces. If you move from Alberta to Quebec, you are almost assured of paying more tax. Third, certain government benefits ( are income-tested. For example, I receive the Child Tax Benefit, but only because my RRSP contribution brought my income down below the maximum.

So, it’s impossible to say that RRSPs always make financial sense. In fact, there are too many variables to really know that you’ll have more after-tax income. But there are certain benefits that make an RRSP useful. One example, as mentioned above, is reducing your net taxable income to qualify for government benefits. Another one is income splitting. When only one spouse works, or one spouse has a much higher income than the other, or when one only spouse has a pension, a spousal RRSP allows the higher income spouse to save and invest in the name of the lower income spouse. That way, it is possible to balance income in retirement and both make use of the lower tax brackets. For example, a couple where one spouse earns $85,000 will pay more tax (in the 36% AB tax bracket) than a couple where each spouse earns $42,500 (in the 32% AB tax bracket).

Even if the RRSP doesn’t reduce tax, only postpones tax, it was always useful for reducing the taxation of interest income. For example, GICs and bonds accumulate interest each year and, even if it is not paid, it is still taxed. Holding the GICs or bonds in an RRSP, or now a TFSA, avoids that tax leakage until a withdrawal is made. A TFSA has a very similar financial benefit, after tax, as an RRSP, but they have different limits and different timelines. An RRSP is meant for saving in anticipation of not working: maternity, disability, sabbatical or retirement. Because withdrawals increase your taxable income, any year that you have little or no income is a good opportunity to withdraw funds from your RRSP.

For someone planning to retire before age 65, without an employer-sponsored pension, RRSPs almost certainly make sense when your income is over about $40,000. Because you can elect to start CPP anytime between age 60 and age 70, and OAS doesn’t begin until age 65, you will likely have less income before age 65. That is a great opportunity to make withdrawals from your RRSP.

19 thoughts on “Response to Reader Question #16”

  1. If RRSPS will be your main source of income in retirement then it’s important not to forget that you recieve a tax refund at your tax bracket rate, but when you pay tax on withdrawals – it’s at your marginal tax rate. So even if your tax bracket doesn’t change you should be paying less tax on withdrawals then you recieved in a refund.

    And don’t underestimate the value of tax-free compounding!

  2. My husband and I were having this conversation the other day and planning to discuss with the accountant and portfolio manager…is there a point($ value) at which you should stop contributing to an RRSP? or is it always the most tax efficient way to invest? (in conjunction with the TFSA?)
    Our registered and non-registered accounts are pretty much equal…we max. the RRSP and TSFA and put everything else into non-reg. accounts….is there any other way?

    Interested to hear from some others on this!

  3. Kris: Marginal tax rate and tax bracket both mean the same thing. Your average tax rate will be different from your tax bracket. Maybe I misunderstood what you were trying to say.

    Further, tax-free compounding avoids tax leakage (paying taxes along the way), but it doesn’t reduce your total taxation (or increase your after-tax growth). If you’d like an Excel spreadsheet that shows this, let me know.

  4. ldk: An RRSP is usually the most tax efficient way to invest. The point where you would stop is when your retirement income is going to be greater than your current income. You may as well either retire or spend more now.

    Other options for reducing taxation are: borrowing to invest, investing in flow-through shares or investing within a life insurance policy. Those are all things that an accountant would either caution your about or recommend against.

    As long as you have your income-producing investments inside RRSPs/TFSAs and growth investments (capital gains) in the non-reg accounts, you’re doing it right.

  5. I always figured the additional compounding aspect of pretax dollars was the big advantage? Having 1000 dollars pretax in my financial toolbox as opposed to 680 after tax.

  6. Robert: I’m still not entirely convinced that just because you’ll make more in retirement you’re better off putting your money elsewhere.

    Not only do you receive the tax credit now, the RRSPs also grow tax free. So yes you’ll be taxed on that growth when you withdraw it, but you’re receiving growth you wouldn’t have received otherwise.

    I *plan* to make the same or more in retirement, but that doesn’t equate to being able to retire now. So your comment about retiring if my retirement income is going to be greater than my current income doesn’t fly. I can’t retire off of $6000.

    I ran the numbers once quickly and the TFSA and the RRSPs came out about the same, but I’d like to revisit this some more when I have time. Of course I plan to have both along with some income producing properties as well.

  7. Robert: I did mean average tax rate, and not marginal tax. thanks!

    And I would like to see your spreadsheet, avoiding the ‘tax leaks’ as you call them, should allow that extra money to compound further and make more money over the long haul. That was my understanding anyway.

  8. Andy: I’m sorry if I was unclear. I meant that once your retirement income is equal to your current _investment_ income, you can retire. If your RRSP can pay you $50,000/yr (for easy numbers) and you want to retire on $50,000/yr, consider just spending the money you would have contributed. I bet a round of golf, or a vacation, is more enjoyable at age 55 than at age 75 (or whenever your health starts going downhill).

    You said: “Not only do you receive the tax credit now, the RRSPs also grow tax free. So yes you’ll be taxed on that growth when you withdraw it, but you’re receiving growth you wouldn’t have received otherwise.” I believe that’s a misconception. If you spend your tax refund, it’s not true. If you invest the tax refund, I bet you come out the same. I’ll put it all in the spreadsheet Kris requested and provide a link.

  9. Robert…thanks for the feedback. What you described (income producing investments in reg. accts and growth investments outside) is essentially what we are doing now. (and we do borrow to invest as well, but that’s another topic!)
    Our investments would currently support about 1/2 our desired ‘income in retirement’ (we are 39) so we have a ways to go yet.

  10. I have prepared a spreadsheet that I think allows anyone to explore all that we’ve discussed, assuming your marginal tax rate stays constant. It’s at: If anyone finds any errors, please point them out.

    There are two tables (tabs at the bottom). The first shows the importance of investing your tax refunds from your RRSP contributions (compared to a TFSA). On the second, I’ll let you come to your own conclusion about the value of tax-free compounding in an RRSP, seeing it’s all taxed proportionally at withdrawal.

  11. Interesting discussion. Thanks for the post and spreadsheet Robert!

    One other idea to toss around to make even more options for people is to consider what happens if you have a lower retirement income target? Say about $30,000/year.

    Then if you are a couple and income split pension and RRSP income you could potentially stay below your basic deduction each (and pay no tax on the RRSP or pension withdrawal up to $20,764 using the federal number). Then make up the rest from your TFSA with again no tax. So then the RRSP gets the tax refund upfront and avoids tax at the other end.

    Of course that is only an option if you have a lower income target, otherwise the idea falls apart.


  12. Robert – I would make two changes to your spreadsheet RRSP vs TFSA.

    1) In order to compare apples to apples, you must invest 6800$ into your RRSP account. It’s the equivalent take home money saved as 5000$ in your TFSA.
    That results in a 1,380,878$ total compounded over 37(?) years. (Which btw – most of us won’t have that much TFSA room when we retire).

    2) No one would withdraw their RRSP as a lumb sum.. on top of their Employment income in their last year of employment and then live off of it, for the remainder of their retirement. So Taxing your RRSP at 36% is a bit exagerated. Using an average tax rate of 20% (the average tax rate from the 50,000$/year employment income) is more reasonable… although the RRSP wins out up to a 26% average tax rate, which is around 90,000$/year income – in AB)

    This calculation gets scewed a bit if you have a pension contributing a base amount income.

  13. Sorry – at a 36% tax bracket, you have to save 7800 in your RRSP – that would be 5000 take home pay saved. Which means the RRSP wins out until about a 30% average tax rate… I shouldn’t do math before my tea!

    And for the tax-leakage spreadsheet, if you use an average income tax rate instead of the top 36% bracket, your RRSP will win out. Up to about a 35% average tax rate, which is a HUGE amount of annual income… and not likely a regular thing in most retirement portfolios.

    I’ll buy your asset allocation, but I don’t think it’s reasonable to assume no capital gains throughout your retirement savings.


  14. Kris: I’m not going to debate with you, since I trust you did the math. And the spreadsheet is there for everyone to see for themselves. I think you’re using average tax rates because you’re assuming in retirement you will have only RRSP income. You’re right that pension income (including CPP & OAS) affects that assumption.

    One of the things I tried to show, in the RRSP vs. TFSA spreadsheet, was that if you DON’T invest your tax refund, you fall behind with the RRSP (the $5000 vs. $6800 you mention). When your employer pays a bonus into your RRSP, that works. I’ve seen people make regular RRSP contributions, after the employer has withheld tax, and spend the refund on a new car or a vacation. (Form T1213 helps address this.)

    The whole reason for the spreadsheet is: assuming the same tax bracket in retirement. If that’s 36% in AB because you earn over $80,000 but under $120,000, or 32% for lower income, or 35% or 40% in another province isn’t the issue. If you’re paying tax on withdrawals at the same marginal tax rate, RRSPs work as shown in the spreadsheet. If you can use RRSPs to split income with a spouse, then both take withdrawals in a lower tax bracket, they work great (as Tim pointed out).

    I’m currently paying tax in the 32% tax bracket and making spousal RRSP contributions. Then my wife decided to go back to school to be a teacher. That made me question my contributions, now that there’s a chance for pension income and the same marginal tax rate in retirement. I think we’ll make an RRSP withdrawal while she’s at school, using the lower tax brackets.

  15. I’m using an average tax rate because that’s the tax I pay on my yearly income – regardless of it’s source. You don’t order your income as in I recieve OAS first, then CPP, then my RRSPs… thus my RRSPs pay the highest taxes?

    If you spend your RRSP Refund of 1800, that would be the TSFA equivalent of Saving 3200$/year. You get the benefit of tax free savings still, but it’s not in the form of retirement savings, it’s in the form of a vacation, or big screen tv. Why save in my TSFA, and forego vacations, when I can save a similar amount in my RRSPs and have a vacation?

    I believe the RRSP vs. TSFA argument has more to do with what other income you will recieve in retirement as opposed to what your relative tax brackets will be.

    I absolutely agree with your income splitting argument, if one spouse makes more then the other. (If both spouses have similar incomes, and contribute evenly to their RRSPs…)

    And yes it’s likely all of my retirement income will come from my RRSPs, and OAS. CPP or other pensions will be minimal or non-existant.

    and I thank you for a good debate 🙂

  16. Another factor to consider in this debate is the amount of seniors benefit clawbacks from RRSP/pension income, detailed at

    When these are taken into account, the actual average tax rate on retirement income can be significantly higher than preretirement income. This suggests that TFSA contributions, which do not contribute to income for clawback calculation purposes, may have more value in a situation where retirement income is fairly high.

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