Pensions & RRSPs
Posted by Gail | Filed under Retirement Planning
One of the questions I routinely get from people writing into the site (and from friends) is the whole “Do I need to buy RRSPs if I have company pension plan?” since I hang with a lot of teachers, my answer is often, “Nope.” But let’s look at the issue in a bit more detail for those of you who may not belong to one of the best pension plans in the world!
RRSPs were created to allow all Canadians to take responsibility for their retirement planning. RRSPs are the only way the self-employed and those individuals employed by small companies who don’t offer a pension plan have of saving for their retirement on a tax-deferred basis. This tax-deferred savings option has been available to members of government and corporate registered pension plans for decades since contributions to these plans have never been treated as taxable benefits.
For those who are fortunate enough to have a pension plan at work, the question then becomes, “Should I also be contributing to an RRSP?” Well, like most things to do with money, it depends.
The first thing you have to figure out is how good your company pension plan is. Is your plan well funded? Is it well protected? And will it provide what you’ll need to retire comfortably? You’ll need to go ask your plan administrator some questions before you decide.
As I said earlier, the teacher’s pension is terrific. And if you have a government pension (if you’re a civil servant, a policeman, a fireman or a nurse, for example) and plan to work until you qualify for full benefits, then you’ll probably be fine sticking with your pension plan.
Think about when you’re likely to retire too since most pension plans penalize you heavily for drawing benefits before the normal retirement age. If you think you may want to drop out early, then having some money in an RRSP might be a good idea. But if you’re going to sweat it to the very end, you’d be better off maximizing your TFSA every year before looking at an RRSP.
If you decide you do want to contribute to an RRSP even though you belong to a pension plan at work, know that the calculation is slightly different for you than for folks who don’t have a pension plan, since the contribution to the pension plan affects how much you can put in an RRSP.
A pension adjustment (PA) is calculated to equalize, at least somewhat, the benefits received by those who belong to a pension plan and those who don’t. The PA reduces the RRSP deduction and represents is the amount contributed by an employee and/or employer to an employee account in a defined contribution pension plan or deferred profit sharing plan, or the value of pension benefits accrued during the year in a defined benefit pension plan. In many cases, the PA leaves very little RRSP deduction room remaining, so contributions to an RRSP are moot.
For everyone who does not belong to a company pension plan, the question of how much to contribute to an RRSP is easily answered: As much as you can afford up to (this should be your goal) your maximum allowable limit.
The maximum you can contribute n 2009 is 18% of your earned income in 2008 to a maximum of $21,000. So if your earned income — total of employment income, net rental income, net income from self employment, royalties, research grants, alimony or maintenance payments, disability payments from CPP or QPP and supplementary UIC payments — is $35,000, your contribution limit would be 35,000 x 18% = $6,300.
Don’t let a big number put you off; even a small contribution made early and regularly will put you in a better place than totally ignoring your future. And an RRSP is still the best way to plan for the future and beat back the tax man.
September 8, 2009 at 7:17 am
Thanks for this, Gail. As a civil servant, I’ve often wondered about this while watching your show.
One additional question for you. As very young government employee, it’s looking more and more like benefits such as defined benefit plans for civil servants may not be around by the time I retire (a move over to defined contribution, for instance).
If that were to happen, how would that affect my pension? Do they typically ‘grandfather’ existing employees? Do I need to be maxing out my RRSP just in case that happens to make up for the shortfall?
September 8, 2009 at 8:54 am
I am glad to read about RRSPs and gov’t /teacher jobs. I teach and am incredibly late in the game to start RRSPs at that 4 0 number this month. It’s good to know I haven’t totally messed up my future, though I wish my spouse, with a sad sad pension plan would try to save SOMETHING be it savings or RRSP or whatever.
September 8, 2009 at 8:59 am
Kate:
I’m in a similar position. I work for the federal government and have about 28 years to go until retirement. I’m certainly not naïve enough to think my pension plan will be exactly the same in 28 years as it is today, but I have little doubt that it will still be there in 28 years in some form that closely mirrors its current state. That being said, it’s a legislated plan and is protected to a much greater degree than any corporate pension plan will ever be. The same goes for OMERS or whatever government plan you belong to. As for corporate pension plans going to defined contribution, often there is a grandfathering provision. I would wager that if a government plan ever goes that route, everyone currently in the plan (or, say, everyone with two years of service) will be grandfathered and will keep their DB plan. Can you imagine the anger if we were all forced into a DC plan after years of contributing to a DB plan at the expense of our own RRSP. No one can say for sure what future governments are going to do, but I think we’re fairly safe.
If you only have enough money to contribute to either a TFSA or an RRSP, I would recommend a TFSA, but if you have the money sitting around, max out that RRSP too! Even though my RRSP contribution room each year is only $3200 to $5000 (it would be about $12 000 to $13 500 without the PA), I max it out every year in addition to my TFSA. You’ll love the tax deferral. The other thing to consider is whether your post-retirement income will be higher or lower than your pre-retirement income. You don’t want to defer tax now only to be paying more tax on the same income later. That’s why I’d say TFSA first.
Also, when you consider how much you’ll need in retirement, consider all of the deductions you won’t be paying in retirement. I plan to retire after 30 years of service and that should result in a 60% pension, but I once estimated that to be closer to 73% of my pre-retirement net income. In retirement, I won’t be contributing to CPP, EI, my superannuation/pension plan, and I won’t be paying union dues. It all adds up quickly.
Hope that helps.
September 8, 2009 at 9:14 am
Thanks, Bjorn! That helps a lot.
September 8, 2009 at 9:15 am
Thank you for today’s post Gail. It did clear up a lot of questions for me.
What I decided this year is that the TFSA seems to make the most sense for us, for reasons stated by Bjorn. I am in a job where my income goes up yearly based on years of service, so it only makes sense to me to be taxed on the money now, rather than 30 years from now when I retire and am in that higher tax bracket.
I will say though, that the whole TFSA thing was very confusing to me and I had to read a lot of stuff in order to figure out why a TFSA made more sense than an RRSP for me.
I am curious though as to whether an RRSP will have a larger longterm return. I can’t seem to find a whole lot these days with interest rates above 1% (in either TFSA’s or RRSP’s). I’m not sure if I’m just not looking in the right places, or if it’s just because interest rates are at their all-time low right now.
September 8, 2009 at 9:19 am
Thanks Gail, you read my mind!! (both my partner and I are teachers and had a discussion about this)
September 8, 2009 at 9:29 am
Marcie:
The return you get from an RRSP or TFSA is dependent upon what you’re invested in. With an RRSP, you can reinvest the tax savings (deferral really), but other than that, it just depends on what you have your money invested in. You can invest in stocks, ETFs, mutual funds (watch those MERs), bonds, GICs, etc. Keep in mind, a TFSA does not have to be a savings account as the name implies.
September 8, 2009 at 9:40 am
One of my concerns about moving to a government job would be if you get laid off after 5 or 10 or even 15 years of service. Then you only get some of the pension (right?) and are starting much later doing rrsps.
September 8, 2009 at 9:53 am
An interesting post, Gail.
I’m a college professor and I realize that my pension plan is quite good (I’m just grateful to have one!). I’ve only just begun my career, so that retirement is a ways off… however, I have been contributing regularly to my RRSP’s for several years now, always maxing them out. I invest my money in mutual funds and while I (sadly) lost a bit of money in the last year, I know that it will be recuperated shortly and work well for me in the long run.
I’ve never contemplated the thought of having one or the other (pension vs RRSP’s)… I’ve been guided throughout the process by my parents and my financial advisor and never has anyone suggested to me that I not invest because I have a good pension plan. I figure that if I can afford it, why not do it? Sure it means I have a bit less money to spend on “stuff” (I love that quote!) every month, but I know that when I decide to retire, I’ll be able to enjoy myself freely and hopefully without many worries.
September 8, 2009 at 10:02 am
I saw your picture in the Ottawa Citizen this morning
September 8, 2009 at 10:11 am
Kerry:
That is somewhat true. With my plan, if I were to be laid off I could choose to take a deferred annuity payable from age 60, or an annual allowance (if between 50 and 60 years of age) which is a reduced pension. The other option would be a transfer value if laid off before age 50. The transfer value option is basically a lump-sum of the future value of your pension benefit instead of receiving it as a future monthly benefit. None of those options would result in a particularly massive pay out if I were to leave after, say, five years of service, but it’s not like I’d be losing my contributions entirely. Then again, one of the main reasons I took a job in the public service is for the job security.
September 8, 2009 at 10:13 am
Chronic pension underfunding could spell the end of the current format of pension plans. Plan for the worst, hope for the best.
If you read on the internet, there is a shortfall in pension funding everywhere that is being made worse by the economic crisis.
September 8, 2009 at 11:08 am
A great post Gail!
I am 25 and won’t be able to contribute to my company pension plan for another year (October 2010) once I start contributing, the companies portion is not vested for another two years.
So if in the next three years I get the proverbial ‘boot’ from my current employment, I’ll lose any company contributions. For that reason, I plan on contributing as much as I can to RRSP’s until their portion is vested – that way I have a back up plan just in case.
We have a defined contribution PP, that is the employee and the employer each contribute 5%.
September 8, 2009 at 11:35 am
We’re fortunate that my husband has a good (government) pension plan.. however, I’m self-employed so this year I’m maxing TFSA’s and have my own RRSP’s and RESP’s. I wish I could max out the RRSP’s as well but as my salary grows I keep putting more in… I’m pretty happy with how it’s all going now. A few years ago I wasn’t saving a thing and felt very uneasy… luckily I have a long way to go before retirement and with having my own business from home I might just keep working well past retirement age but I figure you just never know what’s going to happen… better to be safe
September 8, 2009 at 12:17 pm
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September 8, 2009 at 12:51 pm
I think the key to understanding what investment vehicle you should be using depends on many factors to name a few your marginal tax rate, purpose for saving and incentives. The general public talks a lot about RRSP’s but forget the benefits that can be had using non-registered investments and even the new Tax Free Savings Account. Understand the difference between tax sheltered and non-tax sheltered investing, the impact of taxes and you will get a better sense as to which vehicle would work best for your situation. Do I have RRSP’s, yes I do along with a Defined Benefit Plan, non-registered margin account, a tax free savings account and a real estate portfolio, but we’re all different so explore the option(s) that will best meet your present and future needs.
September 8, 2009 at 8:30 pm
Maybe I’m overcautious, but I max out my RRSPs even though I have a pretty decent pension plan. It’s hard to predict what’s going to happen in the next three decades.
September 8, 2009 at 10:11 pm
Let’s play devils advocate for a moment –
I’m reading that a lot of people maximize there RRSP’s contributions each year because they are overcautious, etc. By maximizing your RRSP’s today are you really saying that your income is high and you’re paying too much tax, so you would like to make an RRSP contribution in order to minimize your taxes payable? Are you also saying that you hope to withdraw your compounded tax free investment during your retirement years when your income and tax situation are relatively lower? Are you really saying, because this is what I’m hearing, is that you’re planning to be worse off at retirement than you are today. Think about it, you’re planning to be at a lower tax bracket at retirement than you are at today, does that not mean a lower income?
I’m not sure about everybody else, but I’m planning a retirement where my income is equal and/or greater to my income today. My goal is to build wealth, not set myself up for less in the future.
Just a fun little spin that you can put on RRSP’s to show that it’s important to be diversified (RRSP’s, non-registered portfolio, tax free savings account, real estate, etc.).
Don’t get caught up in the RRSP hype, you may end up like so many people I’ve seen where they have all of their investments in a registered investment which opens the flood gate to estate, taxation and income issues in the future. Find a balance between all of your investment options through a viable financial plan.
September 8, 2009 at 10:37 pm
oh boy….
I am feeling really deprived right now. No pension, no hope of maxing out the RRSP contributions (if we want a life)…. but on the bright side no debt (except the mortgage) and we DO have some room for a life while the kids are still young. I know I am robbing my future to live this way and it does stress me out. HOPEFULLY we are putting enough away — at least it’s something, right?
The jon with a pension seems like a dream to me, neither my husband nor myself nor anyone in our direct circle of family and friends has this option… you people are so fortunate to have that perk!
September 8, 2009 at 11:26 pm
I have 8 years to retirement, have just discovered your show and this blog, and am in a quandry about RRSPs. I stayed at home with kids, so have only been working for the last 15 years – pension will be pretty small. I don’t have a lot in rrsps, and stopped contributing to this awhile ago as I read somewhere that for people like me, with fairly low income, that in retirement, if I withdraw just a bit from rrsps, it will be clawed back. Am I misinformed?
September 9, 2009 at 10:00 am
Irene – You will be taxed on the money you withdraw from RRSP’s – not ‘clawed back’. Keep contributing, or saving money somewhere!
September 9, 2009 at 10:02 am
*pol – we don’t go near maxing our rrsps either. I think if you maxed them for your whole working career you might end up oversaving in that vehicle. This is just from the calculations from my financial adviser and our future projected income requirements.
Unfortunately we actually put our rrsp contribs on hold in August and probably for the rest of the year since I had a reduction in work due to ‘the recession’. It feels pretty bad to do that, after paying regularly for so many years but it will hopefully be temporary. We have no emergency fund and I wanted the extra cash to start that.
September 9, 2009 at 2:33 pm
Money Coach, funny to think that if people don’t have enough to put into RRSPs that they would really have enough for a real estate portfolio.
September 9, 2009 at 7:49 pm
@ Money Coach – By maximizing my RRSPs today, I’m saying the future is unpredictable and it’s best to be prepared by having a big, fat cushion.
And don’t assume that people who maximize their RRSPs aren’t also maxing out their TFSA contributions…and a healthy real estate portfolio. Sometimes it’s not one or the other.
September 9, 2009 at 10:39 pm
Great posts.
Diana – You don’t need a lot of money to purchase real estate, the key is having specialists working for you to make the deal happen. The last property I purchased cost me $350 out of pocket for the home inspection, not because I’m special but because I have a team of professionals that work in real estate. Yes, a $190,000 home where I receive $1275 per month which covers the mortgage, property tax and property manager and leaves extra in the account for maintenance only cost me $350 out of pocket.
Ann – First off, congratulations on being able to maximize your RRSP’s, not too many people can do that. The only point I was trying to stress in my original post was for people to diversify their savings and talk to a specialist to determine what option makes sense for their current needs and future plans.
November 24, 2009 at 12:30 pm
I’ve just discovered this site and so just read Irene’s and Jesse’s posts. I have been doing alot of research on this subject and conclude that RRSPs seem like the way to go for everyone BUT low-income seniors and high-income seniors. Irene, if you think you would qualify for the Guaranteed Income Supplement (GIS) then please think twice about contributing to an RRSP. Withdrawing taxable RRSP benefits while a pensioner could likely result in a reduction, or clawback, of the GIS. This is a big penalty for all your hard work scrimping for an RRSP. Other means-tested benefits may also be lost. See http://www.hrsdc.gc.ca/eng/isp/oas/oasrates.shtml for more details on income levels for the GIS. But that doesn’t mean you stop putting money aside. Keep on saving! – I think its where it is put that makes all the difference for a low income senior.
If I knew I would likely have only a small pension when I retired, then I would forget the RRSP and put my money in a TFSA instead. That way I’d be building up my own “pension” fund without facing future taxes on it (be careful about investing much of it in mutual funds given your few years to retirement though- maybe 30% in mutual funds unless you think you will need the money in the next 10 years in which case much less). Earnings and withdrawals in a TFSA doesn’t affect the GIS later on and I wouldn’t be forced to begin taking it out at age 71 like I would with an RRSP. If I somehow managed to start making more money and moved into a much, much higher taxable income bracket, then I might take out some of my TFSA to buy an RRSP BUT only enough to reduce my taxable income back to the lower level. Bottom-line: I’d choose TFSA over RRSP if I was going to be a low-income senior or for that matter a young person just starting out with low taxable income.
At the other end of the spectrum, those with good defined-benefit plans expecting to receive pensions and other income that could result in clawbacks from Old Age Security should also think twice about contributing to an RRSP. This is because having to take out RRSP funds beginning at age 71 on top of an OAS could result in what amounts to an extra 15% tax, or clawback, on the OAS as well as a forced bump into a higher tax bracket. Ouch. Double tax hit! Also, if you will be getting a severance benefit when you retire and don’t contribute to RRSPs over the years then you have built up room in your RRSP to put your severance pay in to avoid a big tax hit and gain more flexibility for financial planning. I wish I’d figured this out years ago as I am 2 years from retirement with maxed out RRSPs. If I knew then what I know now I would have paid off my mortgage faster, built up the emergency fund, invested outside of the RRSP – TFSAs are awesome for this – and if I did contribute to RRSPs I would have contributed just enough to bring me into the next lower tax bracket. Now I must figure out how to strategically move funds out of the RRSP into non-registered investments before my 64th birthday – in other words before the OAS and dreaded clawbacks. Not a bad problem to have but no body likes to give away their hard earned funds to the tax department!