Withdrawals Are Considered Ordinary Income:
RRSPs turn all kinds of income into ordinary income. Dividends from Canadian companies and capital gains receive special tax treatment outside of an RRSP but if they’re held within an RRSP this won’t happen. Any money earned in an RRSP is considered ordinary income when withdrawn. This ordinary income gets taxed at your marginal tax rate.
Withdrawals Will Impact Income Tested Benefits:
RRSP withdrawals can impact government benefits in retirement. This can lead to claw backs on OAS or GIS. Due to the high claw back rate on GIS (50%+) this is a BIG drawback for very low income families.
Contribution Room Is A Scarce Resource:
RRSP contribution room will never come back. Unlike a TFSA, if you make an RRSP withdrawal that contribution room is forever destroyed, you will not get it back the following year.
Contribution Room Is Based On Income:
RRSP contribution room is based on your gross income. In low income years you’ll accrue less contribution room. TFSAs on the other hand always accrue the same amount of contribution room regardless of income.
Less Flexibility To Share Available Contribution Room:
Spouses cannot contribute to each other’s RRSP. RRSP contributions can only be made using your own earned income. Making an RRSP contribution in your spouses name is a good way to get audited by the CRA and receive hefty fines/penalties. To get around this, it is possible for the high income earner to pay all the household bills/expenses which then frees up the spouses income to go towards RRSP contributions.
Mandatory Withdrawals At Age 72:
By the end of the year you turn 71 RRSPs must be converted to a RRIF which has prescribed withdrawal rates. These minimum withdrawals must be made regardless if you need the income or not. These withdrawal rates escalate each year until age 95 when they hit 20% of the balance. These mandatory withdrawals can create a tax burden that must be managed properly to avoid unnecessary taxes.
Tax Refunds Get Spent:
This is the BIGGEST drawback of RRSPs! If you spend your tax return rather than save it then watch out!
The most efficient way to use an RRSP is to make pre-tax contributions. If contributions are made with post-tax income then you get a tax refund when you file your taxes at the end of the year. This is a huge risk for many people who spend their tax return each year.
You pay tax when you eventually withdraw money from an RRSP so its very important that the tax refund you get today also gets saved. Otherwise you essentially get hit twice, once now when you spend the refund, and once again in the future when you pay tax on withdrawal.
This can cost you $100,000’s!
Using our example from above, spending the tax return will decrease the cumulative RRSP withdrawals by $291,473!Ouch!
Annual $3,517 Post-Tax Contribution, Tax Return Is Spent
$691,572 Cumulative Withdrawals (After-Tax)
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