Is it Really Necessary to Contribute to an RRSP?
Article revised on 28 February 2020
RRSPs are popular. Everyone, including you, your neighbours, colleagues, family members and friends probably contribute to an RRSP. But are you doing it for the right reasons? And is it right to do so?
Many people contribute to RRSPs because they want a tax refund. They do so without a plan and no idea how much they need to contribute for a comfortable retirement. Others are under the false impression that they need to contribute until they hit a “magic amount”, and that the amount is the same for everyone.
The truth is that you might need to contribute very little to your RRSP, or even not at all. It depends on three essential factors.
The first factor is the age at which you would like to retire. If you think you will work until your death, you don’t need an RRSP. But that means you have to be able to work until an advanced age, and have the will to do so!
2. The source
The second factor is the source, or sources, of your income replacement once you retire. If you contribute to a defined benefit pension plan, the number of years of service accumulated at the time you wish to retire is important.
We now know that you can contribute for 40 years. That adds up to a retirement income of 80% of the salary of your average best earnings over five years.
80% is not 100%. But this 20% difference may not affect you much once you retire.
You’ll obviously no longer need to contribute to many social programs such as the Québec Pension Plan (QPP), employment insurance and your pension plan. But you’ll still need to have accumulated 40 years of service contributing to the plan…
You should also know that the pension benefit is reduced at age 65 because it’s “aligned” with the QPP. Furthermore, the benefit amount will only be partially indexed during the years of retirement, essentially reducing the actual purchase power over the long haul.
This argument alone forces us to consider alternative sources of retirement income such as RRSPs to compensate for this loss of purchase power.
3. Quality of life
If you don’t have access to a defined benefit pension plan, you’re in an entirely different situation. You may need to contribute more to your RRSPs. But how much, exactly?
That’s why the third factor to consider is your quality of life just before retirement. If you earn a modest income prior to retirement, you’ll need less RRSPs than if you earned a higher income. In fact, you would need more retirement income, i.e. more accumulated funds, to replace an income of $75,000 than a net income of $25,000, for example.
Some people believe that life costs less when you retire than it did during the so called “active” period. Careful, however! Some expenses will cost less, but it’s not a given for everyone.
This depends on individual lifestyle habits and needs right before retirement, as well as goals. One of the rare expenses that can make a real difference is a couple’s decision to keep one vehicle rather than two. But make sure this decision meets your needs.
Still don’t know whether you need an RRSP for your retirement? Don’t worry, it’s meant to be confusing. The only possible conclusion is that there are too many factors to consider in each situation to be able to provide an answer for every case in this article. You need a retirement plan. There’s no way around it. Your financial security advisor is the person best suited to design a plan tailored to your specific needs, goals and values.
Note: This article is intended for information purposes only and should not be construed as legal, financial, tax or other advice. The circumstances or factors may vary depending on your individual situation. We encourage you to consult a professional before taking action. La Capitale may not be held liable for any consequences arising from any decision taken based on the content presented in this article.
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