The RRSP deadline is Feb. 29, so you have just three days left to contribute. I’ve already put money into my own registered retirement savings plan.
Why not wait until the last minute, as many people do? I worried that missing the deadline could cost me money.
Last year, I had lots of freelance income that wasn’t taxed at source. So, if I contribute to an RRSP, I can write a smaller cheque to the government when I submit my 2011 tax return.
So, why should you contribute to an RRSP if you haven’t done so yet?
Here are the pros and cons, as I see them.
You want to get a big refund on your tax return.
Pro: If you get a cash windfall, you can do home and car repairs, contribute to an education savings plan for your kids or repay outstanding debts.
You believe it’s better to use a lump sum from your tax refund to tackle long awaited projects than to pay interest on your credit cards or line of credit.
Con: Instead of spending the refund, you should be reinvesting it into your RRSP. If you don’t put the money back into the retirement plan, you could be better off not using RRSPs, says author Talbot Stevens.
Suppose you put $3,000 into an RRSP and get a $1,200 refund. You’ve really put only $1,800 into your RRSP – since you’d have only $1,800 after taxes if you cashed in the $3,000 RRSP in the same tax bracket (40 per cent).
If you put the $1,200 refund into your RRSP, you’ll have $4,200 growing for you (including the original contribution), or 40 per cent more. That’s a better way to maximize your RRSP deduction.
You want to save as much as you can for retirement.
Pro: Canadians are living longer, but companies are cutting their pension benefits. Some can’t manage their existing obligations. The federal government hints at downsizing the old age security pension.
You contribute to an RRSP each year, knowing you may spend up to 30 years in retirement. You hope to make your savings last a lifetime without running out.
Con: You have a fixed deadline to convert your RRSP to a life annuity or a registered retirement income fund at age 71. You have no choice about paying tax on money deferred from tax in your younger years.
You have few options and limited flexibility with an RRSP, since you must cash in the whole amount at 71 or withdraw a fixed percentage each year, according to a fixed schedule. You pay tax on every penny removed and get no tax breaks for capital gains or dividend income.
As you draw down your RRSP and pay tax on the amount removed each year, whether you need it or not, you may wish you hadn’t put so much money into an RRSP and had invested more outside an RRSP, paying tax as you went along.
Related: RRSP vs. TFSA: Which is better
You want to buy a house or start a business.
Pro: With the home buyer’s plan, you can withdraw up to $25,000 from your RRSP without interest or taxes and repay it over 15 years. Both spouses can take out $25,000 each.
With the lifelong learning plan, you can withdraw up to $20,000 from your RRSP without interest or taxes and repay it over 10 years. The money can be used for your spouse’s education as well. You must enroll in a full-time educational program at a recognized institution.
Suppose you want to start your own business after quitting your job. You have unused RRSP contribution room, so you put extra money into your plan and get a big tax refund. (You can get a loan to do so.) After a few months, you draw down the money, $5,000 at a time, and pay 10 per cent withholding tax. You may pay more tax in April 2013, but your income is likely low enough to avoid a big tax hit.
Con: If you can’t put money back into your RRSP after using the home buyer’s plan or lifelong learning plan, you’ll have to pay higher income taxes each year. That could be painful if you’re not earning much money.
You may do better saving $5,000 a year in a tax-free savings account. Though you don’t get a tax deduction or tax refund when contributing to a TFSA, you don’t pay any tax on income earned inside the plan and on withdrawals.
You can replace money withdrawn from a TFSA the following year. RRSP contributions can’t be replaced once they’re withdrawn (unless you use the home buyer’s plan or lifelong learning plan).
A TFSA is more flexible than an RRSP. You may prefer a vehicle that allows more access to your money, as long as you have the discipline not to use the money for frivolous purposes.