RRSPs (and Spousal RRSPs) – exactly what are they and when should they be used?

Go back to 1957 (sorry, for the younger audience members, probably before you were born!) – this is when RRSPs first came to the financial landscape of Canada.

The original intention – it remains the same today – is to encourage Canadians to set money aside to provide for their own post-employment life-style and personal care.  To reward Canadians for saving, the Federal Governments since that time have allowed us to deduct our contributions (within limits to be sure) from our Taxable Income.  As most people know, the earnings on investments inside our RRSPs is not taxed until we decide to withdraw them along with the original deposits and purchase some form of retirement income plan.

Pretty simple.  Over the years, the annual limits have increased from the original amount of $1,000 dating from 1957, to the more complex formula in use today.  Originally, there was no carry-forward of unused contributions – but we have had that now for more than a decade.

The date/age at which RRSPs and Spousal RRSPs have to mature has changed up and down over the past 5-plus decades – now, we have until December 31st in the year we turn age 71 to decide how we want to receive our income and make the necessary arrangements.  Who knows what changes will come in the future?

It is interesting to note that there is no minimum age at which an RRSP can purchased – technically it could be purchased for a child as soon as they are born and have an SIN – wait you say – a child has no earned income!  But each person has a once-in-a-lifetime chance to make an excess contribution of $2,000 – who says that can’t be made at age 0?  Think about the benefits of compounding!

Should everyone purchase an RRSP or Spousal RRSP?  Short answer is no.  So why not?  Many incorporated small business-owners pull money for their lifestyle using dividends rather than paying themselves a salary – dividends are not considered earned income so receiving them doesn’t create allowable RRSP room anyway.

Other people are the eventual inheritors of substantial estates or have guaranteed future income, so any money added to their post-employment income is going to result in OAS – and perhaps in the future some other Government Benefits – being clawed-back or taxed away.  Therefore, what is the point of saving in an RRSP?

One last point, RRSP and Spousal RRSP contributions should go into the name of the person who has the LOWEST expected post-employment/retirement income from all other sources.  Since we have a progressive (or regressive, depending on your perspective!) income tax system, the ideal scenario is that in a two-person family unit, each person receives an equal amount of post-retirement income – in that manner they will pay the lowest overall amount of tax!

James Dean

James Dean - President ~ Money Canada Limited (MONEY.CA)