(as published in February 2016 SMART BIZ)

Wherever you may be in your own financial planning process, you are now being bombarded about making your RRSP investment before the 2015 contribution deadline of February 29th.

You should not be making an RRSP investment based on the siren song of getting a tax refund. What you put in your RRSP should be part of an overall thought out financial plan. We began that process with my December column about the three keys of financial independence, the first being that you need to take responsibility for it: only you can make the executive decisions reflecting your goals, even while you make use of financial professionals to put it into action. January explained the second key, allocating your cash flow while always keeping net cash flow positive! I was going to explain the third key, how to do that, but the third key can wait for March. This column is about responding this month, or not, to all the ads and pressure from advisors and peers.

Later this year I plan to get into tax planning strategies. The greatest threat to your financial independence is not debt from frivolous spending on credit cards, or excessive fees for financial advice. It is the Canada Revenue Agency. You need to manage your money by using all the (legal) tactics to minimize the tax impact on your cash flow. The RRSP is one tactic to do this.
Understand that an RRSP is not an investment. Yes, I know, we all talk about investment in our RRSP, but this is not correct. How much of your previous year taxable income you decide to defer paying tax on by depositing it in a registered retirement savings plan is one decision. What to invest that RRSP deposit in is a separate decision with different criteria.

This column is about the first decision, but we’ll wrap up with thoughts about your investment choices for the money you set aside in an RRSP.

An RRSP is a good tool for applying one of the four D’s of tax planning, namely, DEFER. The strategy is to avoid paying tax on income as long as you can. The RRSP allows you to deposit a percentage of taxable income, up to a dollar limit, and defer paying tax on it. Say you earned $100,000 and decided to defer tax with a $10,000 RRSP deposit. The marginal tax rate for you in Manitoba for 2015 was 43.4% so the tax payable on the marginal $10,000 of income would be $4340. You could defer paying that tax if you deposited it in an RRSP. If it had already been taxed as employment income, you could then get a refund of $4340! Pretty good deal, right?

Hang on, understand that the $4340 is not really your money, it is CRA’s money; it has only been “loaned” to you. When you take that money out, say for income when you retire, you will have to pay tax on it. The tax “savings” only happens if in retirement you have less income and the RRSP withdrawal is taxed at a lower marginal rate. For example, if your retirement income is $70,000 when you withdraw that $10,000, the MTR is 39.4%; the 4% difference in MTR is a real saving of $400.

That may be the best scenario for a RRSP tax saving. You might be financially successful where you are in the same or an even higher MTR bracket when you withdraw the money. So in your senior years you continue to “defer” tax by not making RRSP withdrawals. But CRA always gets their money in the end so the rules require you to start making minimum withdrawals from age 71. As a result, far too many people end up dying (assuming no spousal roll over) where all registered money becomes income on the date of death. That could mean a half million left in registered accounts would attract the highest MTR of 46.4% (in Manitoba for 2015, soon to be 50% or more when Justin and Greg get finished!).

So in planning your RRSP contribution for 2015, understand the refund is not a tax “Saving”, it is only a “loan” that will have to be repaid, hopefully with a small net real saving, but possibly with a considerable surcharge.

Before you decide to not invest in an RRSP (there, I did it myself!), there is in fact an upside available. Because the RRSP lets you invest the $10,000 in our example, instead of the $5660 you would have had left after paying tax, you have that extra $4340 from the CRA “loan” earning returns. Say you were able to net an average 7.2% return on investment, you would double your money in ten years; that would give you $20,000 instead of $11,320. Even better, add the refund to the RRSP and have $14,340 working for you, $28,680 after ten years! Then we can look into tactics to minimize the loan repayment to CRA.
The RRSP annual advertising campaign may also suggest you borrow the money to make your maximum RRSP deposit, using the tax refund to pay down the loan. Space does not permit a full treatment of this tactic, so just remember, there is no free lunch. All loans have to be repaid eventually, so make sure you have worked out how you are going to do that (while keeping your net cash flow positive!).

Once you have decided how much you are going to deposit in an RRSP for 2015, your next decision is what to put it in. There is a wide, nay infinite, variety of choices, from low (to zero) interest bank accounts to high volatility equity funds. Your criteria become risk tolerance, balance in the types of investments, diversification (sector and geography) and should include dollar-cost-averaging.

If you have left it a little late for considering all these choices as well, just decide the amount for the RRSP and stick it in a registered bank account for now. Come March, look into the investment options and move the money then. That is a good reason to separate the RRSP amount and the investment decisions; while the RRSP deposit has a deadline, you can always move investments in the RRSP later. Indeed, March would be a good time, after the RRSP hype subsides, to review how your previous RRSP investments have been preforming and perhaps change the investment products being used.
Good financial planning will always leave you options.

Fredrick Petrie, author of “THE END OF WORK: financial planning for people with better things to do”, practices financial planning at Mortgage Logic, 1793 Portage Ave., Winnipeg, MB.  (204) 298-2900