Most Canadians are aware of the existence of Registered Retirement Savings Plans (RRSPs) but they really do not know much about how they actually work or how they can use them to benefit them fully. Until just a few years ago, I thought that once you turned age 65, you were allowed to take the money out of them. How little did I know! Unfortunately most Canadians are still in the dark about RRSPs and when it is wise to use them.
RRSPs can be especially useful for regular employees who pay a lot of tax on their employment income. By contributing to an RRSP, they are allowed to defer their income tax. They benefit from lower taxes payable now, and then will expect to pay it later when they withdraw it (presumably when they retire and are at a lower tax bracket).
To help you to determine whether or not it would be worth your while to contribute to an RRSP for 2010, check out the Canada Revenue Agency tax rate information. This will give you a good idea as to what amount of taxes you could save now, but always bear in mind that you will eventually have to pay taxes on the money you contribute.
RRSPs are only good for folks who understand the proper use of them. If you are regularly contributing to your RRSP but in the back of your mind you are using it to save for an upcoming vacation, or even for emergency funds, I would recommend that you stop contributing to it and use a different type of savings vehicle like a Tax Free Savings Account or even a regular savings account. Why? Because your trip/emergency will end up costing you a whole lot more than you could ever imagine due to the tax consequences.
If you are saving within an RRSP, you should only have 3 possible goals: Retirement, to pursue further education under the Lifelong Learning Plan, or to help purchase your home under the First Time Home Buyers Plan. Any other goals for an RRSP are going to be too costly to you.
When you are tucking away money in your RRSP for retirement, then the best thing you can do is pretend that it doesn’t exist. In your mind, the money is not yours until you are no longer working and need to live off of it. Too many folks withdraw from their RRSPs to pay bills or miscellaneous expenses even when they are earning large incomes! This is not a financially sound way to go.
I cannot emphasize this enough. Do not contribute to an RRSP unless you do not plan to use it for anything but those three goals mentioned above. Sure, you may get a tax break. But what good is the tax break if you end up withdrawing it right away?
I understand that sometimes a major emergency occurs and then there are times that folks must use their RRSP resources. In order to prevent this, however, you can save for emergencies first and then once you have three to six months worth of living expenses in a savings account, then you can focus on saving for your retirement. That way when life gets messy you will not even have to look to your RRSP for funding.
RRSPs definitely have their place in a Canadian’s overall financial strategy. Just make sure you use them properly. Otherwise, stay far away from them.
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