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Are Canadians using RRSPs properly?

Recently I’ve read a bunch of stats and articles on RRSP usage in Canada, which makes me wonder if Canadians are using RRSPs properly. I also see this in my financial education workshops where I am surprised at the number of people who don’t really understand the basics of how the RRSPs work and how to use them properly for retirement planning.

How many people are buying RRSPs?

According to The Bank of Montreal’s annual report on Registered Retirement Savings Plan intentions, 67% of Canadians have an RRSP (which is up from 61% in the previous year’s study).

The BMO study also reports that 75% of Canadians plan to contribute to RRSPs this year. Last year’s average contribution was $4,670.

Unused contribution room

Although most Canadians contribute to a RRSP, very few contribute to the maximum. Only one third of respondents said they “usually” or “always” contribute to the maximum. As a result there is about $500 billion of unused contribution room in Canada.

Is this a problem? In terms of the unused RRSP contribution room, it may be a problem for some but it also may not be a problem for others. I have met with lots of people that have unused RRSP contribution room that should not be using the room up. Maybe they are in a low income tax bracket. Maybe they have a really strong defined benefit pension plan or maybe they have ‘enough’ RRSPs already to provide for their retirement income.

Related article: When not to buy RRSPs

For others, high unused RRSP contribution room is simply a function of poor savings habits and lack of planning. For many Canadians, RRSPs remain the best way to save for retirement. These people should develop a strategy to start saving for the future and start using some of their RRSP contribution room.

If you think about it, the whole point of RRSPs is to help save for RETIREMENT. From a tax perspective, the hope is that your marginal tax rate at the time of contribution is greater than your marginal tax rate at the time of withdrawal. If that is the case, then you will be a clear winner with RRSPs.

Related article: The proper use of RRSPs

Withdrawing money from RRSPs

In another recent study by Scotia Bank, more Canadians are withdrawing money from their RRSPs prior to retirement. According to the study, 36% of RRSP holders reported taking money out of their RRSPs this year.

Tax expert Jamie Golumbek wrote a paper comparing TFSAs to RRSPs in 2011. In this paper, Golumbek cites data from a CRA study in 2008 showing that 1.9 million Canadians withdrew $9.3 billion from their RRSPs. Even more alarming was that 80% of these withdrawals were made by individuals below age 60. This suggests that RRSP funds are being used well before normal retirement age to supplement income.

According to a number of other studies by Stats Can, for interpret that out of every 5 dollars contributed to RRSPs, 1 to 2 dollars comes out before retirement. Key life events appear to be highly correlated to withdrawals:

  1. Death of a spouse
  2. Divorce
  3. Loss of job
  4. Birth of a child
  5. Buying a house
  6. Returning to school

Is this a problem? For some people, withdrawing money from RRSPs prior to retirement may be necessary like for a first time home buyers withdrawal or when you lose a job and need money.

Related article: Three good reasons to take money out of RRSPs

However, for many people withdrawing RRSPs while working can be a significant problem especially if it’s used for consumption, holidays or even to pay down debt.

Here’s some of the reasons Canadians withdrew money from RRSPs according to the same Scotia Bank study:

  • Buy a first home – 40%
  • Pay down debt – 16%
  • Convert to a RRIF – 15%
  • Cover day-to-day expenses – 14%
  • Home renovations – 8%
  • Vacations – 6%
  • Education – 4%
  • Medical – 3%

The bottom line is withdrawing money from RRSPs should be done very carefully and with some proper planning.

Have Tax Free Savings Accounts replaced RRSPs?

In 2009, the government introduced the new Tax Free Savings Accounts (TFSA) and there are more and more articles that suggest the RRSPs are now obsolete because of the TFSA. That could not be further from the truth.

As great as the TFSA is, it will not replace the RRSP as a way to save for retirement. There is room for both the TFSA and the RRSP and for most Canadians, the best solution is to use both.

Related article: TFSA or RRSP – Why not do both

My five cents

RRSPs are still and excellent savings vehicle when used properly under the right circumstances. The stats on withdrawals are a little alarming to me but mistakes can be prevented with a little knowledge and planning. For more information on RRSPs, visit my ONLINE GUIDE FOR RRSPs.

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