We are nearing the end of the RRSP season where Canadians flock to their financial advisor or financial outlet and make an annual contribution to their Registered Retirement Savings Plan. This multi-decade ritual seems to be changing.
But first let’s review the basics.
An RRSP allows a Canadian to contribute an annual amount based on the previous year’s earnings plus any carry forward amount from previous years. This year, contributions must be made by March 1, 2017 in order to deduct the contribution amount from last year’s taxable earnings.
The allowable contribution is 18 per cent of your earned income from 2016 to a maximum of $25,370. As mentioned, you can increase your RRSP contribution by including any RRSP carry forward room from previous years.
The initial advantage is any contribution can be used to reduce your taxable income from the previous tax year. Reduce your taxable income and therefore pay less tax.
The tax-deductible feature makes RRSPs a popular option for those with higher incomes and who therefore pay a higher rate of tax.
The longer-term advantage is funds can grow over time without requiring the investor to pay any taxes on that growth.
Regardless of the type of investment income, interest earned, dividends or capital gains, no income taxes are paid on any form of RRSP income.
The initial intent was individuals would use the capital in their RRSP to fund their retirement. That is changing and I will make a comment on that shortly. As funds are withdrawn from the RRSP those funds are added to your taxable income.
The tax advantage is to have an initial tax deduction, grow the RRSP tax free and when funds are withdrawn during retirement most Canadians will be in a lower tax bracket because their income during retirement will be less than when they were working.
In summary, RRSPs make a lot of sense and have been a popular savings vehicle for millions of Canadians.
However, there is new evidence that RRSPs are losing their popularity. Statistics Canada has recently released data showing people are investing less in their RRSP and are withdrawing funds in advance of retirement.
About five million Canadians between the age of 25 and 54 contributed to an RRSP in the year 2000. In 2013 despite there being an increase of Canadians in that age bracket, the total contribution was only 4.2 million people. That represented a decline in RRSP contribution for that age group from $30 billion to $22 billion
More individuals are withdrawing funds from their RRSP. In the year 2000, people aged 25 to 54 had 900,000 withdraw from their RRSPs. By 2013 the number withdrawing funds increased to 1.3 million.
The trend towards investing in RRSPs goes against the grain of what Canadians need. More workers do not have the advantage of a company pension plan. RRSPs will be important for those to provide their own retirement funding.
Plus, we are living longer. Longer retirements mean we need more retirement funding.
The trends of Canadians to save less for their retirement is on a collision course for us needing retirement money for an extended length of time.
The result will be more Canadians outliving their financial resources.