The article “The RRSP has fallen from grace, but there are still plenty of good reasons to contribute” was originally published in Financial Post on February 22, 2022. PHOTO BY CHLOE CUSHMAN/NATIONAL POST ILLUSTRATION FILES.
Jason Heath: Savers who ignore the RRSP’s benefits could be making a costly mistake
Historically, February has been known as “RRSP season,” a time when banks promote RRSP loans and last-minute contributions to claim on your tax return in April. But in recent years, the allure of the RRSP seems to have faded, for banks and for investors alike. Are savers making a mistake as a result?
In 2000, 6.3 million Canadians contributed to an RRSP and the median contribution was $2,700, according to Statistics Canada. By 2019, only 5.9 million people made RRSP contributions, with a median amount of $3,260. If RRSP contributions had simply kept pace with inflation, the median would have risen by over 22 per cent more to $3,858.
The percentage of RRSP contributors between ages 35 and 44 fell from 30 per cent in 2000 to 24 per cent in 2019. Over the same period, the pension coverage rate — the proportion of all workers with a registered pension plan — fell from 41 per cent to 37 per cent, with a disproportionate impact on younger workers. Traditional retirement saving has been on the decline.
Some of the reasons the RRSP has lost ground over the past generation are obvious. Canadian real estate prices have grown at nearly eight per cent annualized over the past 20 years, so more savings are going to down payments and more cash flow is dedicated to housing costs. Rental real estate has also attracted more investment dollars. The TFSA came to be in 2009 and has since competed for contributions at the expense of the RRSP as well.
In recent years, cryptocurrency and non-fungible tokens (NFTs) have also emerged as alternative investments, especially for younger people. An Ipsos survey last year estimated Canadian cryptocurrency ownership at 14 per cent. Crypto and NFTs are not RRSP or TFSA eligible. Although foreign currency is a qualified investment for registered accounts, cryptocurrency does not qualify because it is not issued by a government.
“Rare coins and other forms of money held for collectible value are not a qualified investment,” according to the Canada Revenue Agency’s rules. “Digital currencies, such as bitcoins, are not considered to be money issued by a government of a country and are not qualified investments.”
There are a few Canadian cryptocurrency exchange traded funds (ETFs) from companies such as Purpose, Evolve, and CI Defiance Digital Revolution ETF just launched the first NFT focused ETF on the New York Stock Exchange in December, and it is RRSP or TFSA eligible. Although cryptocurrencies and NFTs packaged up by an investment company go against the decentralization concept of the underlying investments, ETFs provide an investor with a way to leverage the tax benefits of their RRSP or TFSA.
A dollar of RRSP contributions for someone with $75,000 of income saves between 28 and 38 cents of tax depending on the province or territory of residence. At $150,000, the marginal tax savings rate rises to 35 to 47 per cent. For a high-income earner with a long time horizon for their savings, especially if they are likely to withdraw their savings at a lower tax rate in the future, RRSP contributions remain a recommended tax and retirement planning strategy.
For lower income savers whose income is below $50,000 or have no employer matching program on their group retirement contributions, TFSA contributions may be a better alternative to an RRSP. TFSA withdrawals can also be taken in the future to make RRSP contributions as your income and tax rate rises. TFSAs are also more flexible for other short and medium-term financial goals.
Young savers can take advantage of RRSP programs such as the Home Buyer’s Plan (HBP). The HBP allows an RRSP withdrawal of up to $35,000 for the purchase of a first-time homebuyer’s qualifying home. For a couple with a 30 per cent marginal tax rate who can withdraw up to $35,000 each, the RRSP contributions could turn $70,000 of contributions into $91,000 of savings for their first home considering the resulting tax refunds.
If a 40-year-old makes a single $1,000 RRSP contribution that grows at six per cent per year in a low-cost stock portfolio, it would be worth about $4,300 by age 65. This could create an income in retirement of about $240 per year indexed at two per cent inflation, about $145 per year in today’s dollars, albeit assuming a relatively high investment return.
At a more conservative four per cent return, a $1,000 investment could grow to roughly $2,700 at 65, and could generate about $120 per year indexed, or about $70 in today’s dollars.
Most workers will have a higher income and tax rate during their working years than their retirement, making RRSP contributions a tax-effective way to save. Most retirees will not be able to live off Canada Pension Plan (CPP) and Old Age Security (OAS) alone either. The maximum CPP retirement pension in 2022 is $15,043 per year and the maximum annualized OAS pension for the first quarter of 2022 is $7,707. However, the maximum CPP may require up to 39 years of maximum contributions between 18 and 65 to qualify. OAS is residency-based and generally requires 40 years of residency in Canada between 18 and 65 to receive the maximum pension.
Canada’s household savings rate was below five per cent for most of the past 25 years until the start of the pandemic when it peaked at over 28 per cent. It has now been over 10 per cent for each of the past six quarters through the third quarter of 2021. This may be in part because of the uncertainty of the pandemic that Canadians have begun hoarding cash.
The RRSP’s fall from grace has its reasons, but hopefully these higher saving rates will translate into an increase in retirement saving contribution rates as well. There is a compelling case for RRSP contributions for those with moderate and high incomes from a tax perspective. They can be a savings tool for young aspiring homeowners to accumulate a larger down payment. Additional savings are necessary for most retirees to supplement their government pensions. There have also never been more RRSP eligible investment options, including indirect ways to invest in alternative asset classes like cryptocurrency and NFTs.
I have never liked the idea of an RRSP season in February. RRSP contributions are something to consider all year round and for workers at any age or stage of their retirement planning journey. I am hopeful that the RRSP can regain its appeal for long-term savers in the years ahead.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.