Financial advisors like to remind us that every season is the right season to save for retirement. And it is. But for those of us who respond to the validating power of a contribution receipt, RRSP season is as real as winter. That's because the eight belt-tightening weeks between New Year's Day and March 1st are your last chance to lower last year's income.
It's a counterintuitive goal: this business of lowering your income. But depending on how much you make, it can be a powerful incentive.
A VERY TAXING SITUATION
REGISTERED RETIREMENT SAVINGS PLANS (RRSPS) HAVE TWO BUILT-IN BENEFITS.
The big one is that they allow you to efficiently sock money away for the future you. The retired you who travels, hikes, does the occasional guest-lecture, and holds your grandchildren rapt with semi-outrageous stories from your working life.
That's part one. The second benefit is more immediate. When you contribute to an RRSP, you effectively lower your current tax bill.
HOW DOES AN RRSP CONTRIBUTION AFFECT YOUR IMMEDIATE TAXES?
Every dollar you contribute to your RRSP is tax-deferred. Instead of paying income taxes on that money now, you pay it later, ideally when you're retired.
Let's say you live in Alberta and earned a salary of $100,000 last year. Assuming that's your only income (and assuming your tax is deducted at source), you've already paid about $22,000 in income taxes.
You can claw some of that money back by contributing to an RRSP before March 1st. A tax-deferred contribution of $15,000 would recalibrate your income. Now, instead of paying $22,000 to CRA, your overall tax bill would be closer to $18,000, and you might even expect a sizable refund.1
BUT WHAT ABOUT LATER, WHEN YOU WITHDRAW?
At that point, yes, you'll have to pay income tax on that money. But when you pay those taxes, you'll ideally do so as a retiree, when your marginal tax rate might be significantly lower than it is today.
Those two words, might be, are the key.
When you decide whether or not to contribute to an RRSP, what you're really deciding is when you'd prefer to pay your income taxes. CRA will collect eventually. RRSPs give you some freedom to decide if you'd like to be taxed now, while you're a working lawyer, or later, when your entire LinkedIn profile consists of the word “Emeritus.”
KEY TAKEAWAY: Ask yourself if your income is higher today than you expect it to be when you retire. If you're at the beginning of your career, it might make sense for you to take the tax hit now. If you're in your highest-earning years, then it almost certainly makes sense to defer your taxes by investing in an RRSP.*
AN AGE-PROGRESSED PICTURE IS WORTH A THOUSAND WORDS
And while you're deciding how much to contribute, it's worth taking a moment to consider the person you're making all these sacrifices for. You, only older.
UCLA's Hal Hershfield is a psychologist who specializes in the future self. Long-term goals require short-term sacrifices—and Hershfield's research has revealed that many of us subliminally resent the person we're making all these sacrifices for, even though that person is us.
For many, retirement feels so far away that we might as well be saving for a stranger.
GETTING TO KNOW YOU…
One way to bring your future self into sharper focus is by being hyper-specific about your retirement goals. Not, “I'd like to retire around 70.” More like, “I will retire on Friday, June 15, 2045.”
Try it. Write down the exact date you plan to retire. Write the name of one person who'll speak at your retirement party. What do you hope they'll say? Where will you be at 8 a.m. on the first Monday of your retirement? In the garden with a cup of coffee? Swimming laps at the Y? Where will you live? Who will you live with? How—exactly how—will you fill your days and nights?
Hershfield found that people make better long-term financial decisions when they “interact with their future selves”—either by looking at an age-progressed photo of themselves, or by completing the thought experiment described above. In one field study, participants who were asked to vividly imagine their retirement were three times more likely to open a retirement savings account.2
KEY TAKEAWAY: Get to know the 70-year-old you. Write three specific sentences about your own retirement and take steps now to take care of your future self.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.