When Should Canadians Invest in RRSPs?

RRSPs (Registered Retirement Savings Plans) are considered an important part of retirement for Canadians; they enable people to set aside money for the future while lowering the amount of tax payable in the year in which the money was deposited.

But just when should you start investing in RRSPs? And how much should you put in? That depends on several factors.

Author and financial adviser David Trahair urges you to not borrow to invest if you don’t have the money. The rate of return has to be enough to cover the interest on the loan plus any fees incurred just to break even. So if you borrow at 5 percent and your rate of return is 5 percent, you’re losing money after paying the costs of investing!

Also, if you can pay down your mortgage, do so. People are often advised to put the tax returns from their RRSPs toward the mortgage, but are you actually going to? Or would you use it for something more immediate, like a family vacation or fixing your car? It might be tempting to put off paying down your mortgage when interest rates are low, but remember that low rates are not the norm and can change at any time. Your RRSP rate of return has to be better than the interest you’re paying (and will pay) on your mortgage to be worth it.

That goes for any other debts you have. In fact, paying off your other debts should probably come first, as they likely have higher interest rates. Credit cards generally charge the highest rates, so get rid of these debts before any of the others.

How Much Should You Invest?

How much to invest depends on your current and future spending habits. Most people won’t need millions of dollars, according to Trahair. If you’re debt-free and own your own home and car when you retire, then you’ll likely be okay with having 50 percent of your current income in your retirement years. This will vary with your income level, of course, but you won’t have mortgage or car payments and your children will likely be self sufficient by this time.

You’ll also be receiving Canada Pension Plan (CPP) and Old Age Security (OAS) payments if you’re eligible, so these will lower the amount of savings you need. Currently, the maximum monthly OAS benefit is $524.23 and the average CPP pension is $502.57. Your CPP pension is based on what you’ve contributed to it throughout your employment years, but the average person will have about a thousand dollars per month from CPP and OAS combined. (Look in the overview section of Service Canada’s OAS page to see whether you’re eligible for OAS.)

How much beyond that do you think you’ll need? If you want to have an extra $20,000 each year, you’ll need about $500,000 saved. If you feel you should have more, just to be safe, you’ll have to save even more; but putting it all into RRSPs might not be a good idea.

The year you turn 71, you either have to cash out your RRSPs, convert them to an Registered Retirement Income Fund (RRIF), or purchase an annuity. Cashing out your RRSPs would be a bad idea unless you're not dealing with very much money, since the entire amount is taxable. An annuity is something to consider; you get monthly payments for a set amount of years or for the rest of your life, depending on the type of annuity, but beware the fine print on these.

RRIFs are like RRSPs in reverse. Instead of adding to the account, you withdraw from it. You can keep the same investments you had in your RRSPs and the earnings aren’t taxed. However, you do have to make minimum withdrawals every year (7.38 percent in the first year), and this minimum increases to 20 percent when you’re 94 or older. If you have a lot saved at that point, you’ll be paying big taxes. You might also have some losses if the stock markets are down, but you won’t have a choice when it comes to the timing. OAS pensions start getting deducted once your income reaches $67,668 or more.

These are all things to consider when you’re deciding how much you want to contribute to your RRSPs. It’s a good idea to have some savings in RRSPs, but keep in mind how much debt you have, what the interest rates are, what the retirement programs’ regulations require, and the fees which will be charged later when you want to use the money.

About Author David Trahair wants to reveal the truth behind the myths that are so often pitched to unassuming Canadians who are concerned about their financial future.

His book challenges the self-serving claims of people pushing RRSPs and other “investments” and reveals why you should question their claims. Smoke and Mirrors: Financial Myths That Will Ruin Your Retirement Dreams is available in our Web store.