Two Untold Snags Of RRSPs

Two drawbacks have not been mentioned in several decades of media reports of the pros and cons of investing in Registered Retirement Savings Plans and their comparisons to other vehicles for retirement saving. These comparisons of methods of saving for retirement have been greatly energized in the media with the arrival of the Tax Free Saving Account (TFSA) a few years ago with a fair bit of the marketing / reporting favouring TFSAs over RRSPs.

It is generally believed that, as RRSPs are regulated by the government, they are a very safe place to invest your money. However, RRSPs have considerable risk as the government controls their safekeeping and the conditions at retirement for paying back your savings. These conditions include a percentage of your holding that you are required to withdraw, at what age and how often you are required to withdraw it, and how much they will withdraw in taxes. While the government has fiddled around with the percentage of withdrawal required and the age that holders must start withdrawing it on a yearly basis, the untold kicker is in their 1997 plan to significantly overhaul the taxation of RRSPs.

A special report by the Canadian Association of Retired Persons (CARP) offers the following example of this: For every dollar that is contributed by an individual plus every dollar that is invested by Governments in tax relief, the final returns are as follows: Example # 3 Beginning in 2001, a 40-year old Canadian contributes between 7% to 10% of his pay until retirement at 65. RRSP totals $693,072. The final returns are “Federal Government $10.21 Provincial Government $3.10 Contributor $1.82.” In summary CARP reported: “For every $1.00 an individual contributed to an RRSP … future governments would realize a return of $22.14 from income tax while the RRSP contributor would earn $2.94.”

The second snag was experienced by a considerable number of RRSP-holding retirees in 2008 when they had to withdraw investments for their yearly mandatory amount (after conversion to a RRIF). Many of the withdrawals were mutual funds or stocks that had lost 30-50% of their market value and thus were reducing their RIF payout for the rest of their lives by the undue reduction of its capital. To top it off, these investors were reminded that the withdrawal loss they had just experienced was not tax deductible.

The recession magnified the contrast of your RRSP where you are required to eventually withdraw investments (having likely big losses and taxed at your top marginal rate) as compared to: 1) tax-free savings account optional withdrawals with no tax and 2) non-registered account optional withdrawals which are taxed at a half or less tax rate (depending on source of income—capital gains, dividends or interest).

Hedley Dimock, MA, Ed.D, semi retired author.

hdimock@teksavvy.com