RRSPs are not short term savings accounts.
This week, I received a phone call from a client. He asked how much he could take out of his RRSP. I explained the withholding tax on ad hoc withdrawals and the negative effect it will have on his overall Financial Plan. His response was “If I can’t get financing from the bank I am going to take money out of my RRSP to buy a quad for hunting season.” My first thought was if you can’t get financing for a quad, you can’t afford the quad. So, I thought today I would write about RRSPs and why you shouldn’t be using them as a short term savings vehicle.
How much can you contribute to your RRSPs?
RRSPs were introduced to Canadians in the late 50s to help them save for their retirements. With RRSPs, you get an immediate tax deduction, tax sheltering on the growth and a tax deferral until you start to withdraw money in retirement.
A person can put up to 18% of their earned income into an RRSP every year to a maximum of $23,820 (2013). The contribution limit will be indexed for 2014 and beyond. For example, a person that makes 60,000 per year can contribute 10,800 to their RRSP. Someone making 132,333 or more can contribute 23,820.
Related article: How much can you contribute to an RRSP?
RRSP is for retirement.
RRSPs are one of the few vehicles that allow Canadians to save in a favorable way for retirement. Most Canadian’s income in retirement will come from RRSPs, TFSAs, and Pension Plans. Those with higher incomes or strong savers may have more diverse portfolios but my 20 years in this profession says that the average Canadian will have RRSPs and not much else. RRSP savings statistics suggest that most Canadians won’t even have an RRSP but that is for another discussion.
With that in mind, when a person saves for retirement they need to have a 30 or 40-year time horizon on that investment. Sadly, it seems that “long term investing” is now about a 5-year time horizon. Saving for retirement is hard. It requires sacrifice, long term vision, and discipline. Short term gratification may be the ‘Achilles Heel’ for anyone’s RRSP portfolio.
Withdrawals from your RRSP.
Let’s be honest, stuff happens in life that we are unprepared for and sometimes there is no other way than taking money from your RRSP to meet that challenge. I am not talking about those situations. I am talking about the person who uses their RRSPs to go on holidays, buy a quad or pay off a debt. When a withdrawal is done withholding tax is taken off the sum of money withdrawn. 10% on the first 5000, 20% on 5001 to 15,000 and 30% on 15,001 and above. You can see that to get 5000 net you will take a 20% hit. Depending on what the redeemer is using the money for they are probably buying an asset that will decrease in value and have no positive effect on their future income in retirement.
Related article: Understanding withholding tax
We are in a society of instant gratification, “I want it now, and I don’t want to wait.” Money is cheap with low-interest rates. Spend, Spend, And Spend. Retirement is a long way out and I will have time to catch up. Time passes by quickly and any ad hoc withdrawal from an RRSP to meet a gratification, want not a need, will have a detrimental effect on a person’s retirement plan. Before you know it, you will be 60-65 and will not have enough money to retire and more than likely not have whatever it was that you purchased with that withdrawal many years before.
Related article: Principles of Saving Money
Saving money is hard. It requires discipline and vision and yes a saver may have to forgo some short term spontaneous purchases. Save for your fun in a non-registered savings account or a product like a TFSA. Your future income in your senior years should be left in your RRSPs. You can do both, it is a choice.