Can you be overinvested in RRSPs?

Issues include the tax burden of taking money out of the RRSP or RRIF later in life, and the potential reclaim of OAS benefits if your income exceeds the annual threshold, which for 2022 was $81,761. /iStockPhoto / Getty Images

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This time of year investors are bombarded with reminders to top up their Registered Retirement Plans (RRSPs) for the tax deduction and deferral benefits — and, of course, to save for retirement.

But is it possible to have too much in your RRSPs?

Many older investors are asking this question after being forced to take more money out of their RRSPs than they might want or need, especially if they convert into Registered Retirement Income Funds (RRIFs) and the mandatory payout rates kick in.

Issues include the tax burden of taking money out of the RRSP or RRIF later in life, and the potential reclaim of old-age benefits (OAS) if your income exceeds the annual threshold, which for 2022 was $81,761. Dying with too much money in your RRSP or RRIF can also trigger a huge tax bill on an estate.

Having too much money in an RRSP might sound like a good problem, especially for younger investors scraping together funds to make their annual contributions. Still, the question arises as to whether so many financial sacrifices are necessary in younger working years when there are other big expenses to fear, such as a mortgage, daycare fees and savings for a child’s post-secondary education.

“RRSPs aren’t a one-size-fits-all solution, although marketing by financial institutions during RRSP season might make you think differently,” said Morgan Ulmer, board-certified financial planner at Calgary-based fee-for-service financial planning firm Caring for Clients.

Though she’s a proponent of RRSPs, Ms. Ulmer says they tend to work best when someone is in a lower tax bracket when withdrawing funds than when depositing.

Many retirees today are earning more income than they did during their working years, thanks to steadily rising markets over the past several decades and a combination of sources including RRSPs or RRIFs, tax-exempt savings accounts (TFSAs), company pension plans, unregistered investments and business income, and Canada Pension Plan benefits ( CPP) and the OAS.

“Some retired Canadians may actually find themselves in the same or higher tax bracket,” says Ms. Ulmer.

Advantage of tax savings in working years

Mark Chan, vice president of wealth planning at Gluskin Sheff in Toronto, sees an oversized RRSP or RRIF as a “tax optimization problem.”

“Having too much isn’t necessarily a bad situation,” he says.

Mr. Chan notes that many investors don’t know how long their careers will last or how long they will live in retirement, “so it should always be a good idea to have the financial discipline to start saving early in life.”

He also points out the tax benefits of paying into an RRSP, including having it deducted from your income in a given tax year and deferring tax while it grows in the registered account until it’s withdrawn.

“The ability to generate compound growth over a long period of time without paying taxes on that growth each year can result in significant tax savings,” he says.

Some investors also benefit more from the tax deduction during their working years, adds Ms. Ulmer from Caring for Clients.

“For many, it’s a time in their lives when they’re financially strapped – maybe they’re paying off a mortgage or student loan, paying for day care and trying to save for a child’s education – so cash flow is really important,” says she says. “So delaying the taxation of those RRSP contributions frees up the precious money they need at this time in their lives.”

There are taxes if they retire, but presumably those other obligations have ended and customers are in a better position to pay that tax, she adds.

How to reduce an RRSP or RRIF tax shock

There are ways to reduce the tax liability from an RRSP or RRIF withdrawal and prevent or reduce an OAS recovery.

Ms Ulmer says investors can work with advisors on “earnings averaging” strategies, such as B. withdrawing funds from RRSPs before they retire. An example is when someone takes a year or more off work, perhaps for maternity leave, or is fired or decides to retire from work for a while. The strategy is to take some money out of the RRSP while in a lower tax bracket.

Another option is to convert RRSPs to RRIFs earlier than required, which corresponds to the year a person turns 71, Ms Ulmer says. She also notes that some people age 65 and older can split RRIF income with a spouse, which is another way to spread it out and reduce tax liability. Canadians with an existing RRSP entitlement can help reduce their taxable income even if they’re not working, she adds.

Mr Chan says Canadians may also want to retire earlier before the RRSP has to be converted to an RRIF at the end of the year when someone turns 71.

“It’s a common strategy we’re looking at,” he says, “particularly for those in a lower tax bracket than they would be given the minimum RRIF withdrawals that begin the year they turn 72.” grow old.”

He says the strategy would need to be weighed against the loss of tax-deferred growth within the RRSP over time.

Investors could also delay their CPP and OAS payments until age 70 to keep their income low and below the OAS clawback threshold, he adds.

John De Goey, senior investment adviser and portfolio manager at Toronto-based Wellington-Altus Private Wealth Inc., says retirees who are forced to withdraw more from an RRIF than they need to survive could turn back and use some or all of the excess contribute to their TSFA.

“While the minimum withdrawal triggers a tax bill, the deferral on the after-tax money is extended up to $6,500 thereafter,” he says, referring to the current TFSA annual contribution limit.

In general, putting too much money into RRSPs could pose a problem for later high earners, but it’s still recommended, says Mr De Goey.

“As long as your cash flow allows, you should contribute as much as you can afford,” he says, adding that it should be part of a broader financial planning strategy.

“Diversify. Integrate your RRSP planning and wealth mix with other accounts (eg, pensions, TFSAs, corporate accounts, personal money accounts) to improve tax effectiveness while reflecting your long-term goals and risk tolerance,” he says.

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Source: www.theglobeandmail.com