First response, from everyone, is always – Of course they are!
I know. It used to be my response. But is it true?
I don’t have the answer for you, because there isn’t one answer. Oh, there might be, if we could know the future. But then, futurists would have nothing to do.
Let me go over, first, the arguments in favour of RRSPs (I’m in Canada, so I mostly know about RRSPs. I’ve been told that American 401Ks are similar. Maybe. I don’t know. Perhaps someone who does know could comment).
The basic idea behind RRSPs is that a certain amount of your income is put aside in a specially designated bank account (or mutual fund or stock fund). The money you put in doesn’t count as your income in the year you put it in, and any growth in those funds don’t count in the year they grew. When you retire, you will be able to tap into those savings and live off of them. You will be taxed on what you take out, but, since, at that point, you will (presumably) have a lower income, the tax will have been deferred and will be lower than what you would have paid originally.
This was always a good idea, especially for us boomers, because it was unclear whether the government old age benefits would be enough to live on (that was 30 years ago … it’s quite clear now, they’re not).
Now, on to the slightly less obvious bits. The soft wording I used above about the retirement side of the coin is a bit off. I should have written when you retire, you will be forced to tap into those savings. I didn’t write it that way, because it wasn’t my understanding when I first got involved in RRSPs.
I don’t know if I was asleep in class when they said that, or they just kind of glossed over it. But let me repeat. You will be forced to withdraw your savings (and be taxed) according to a timetable of the governments chosing, not your own. Have you been frugal all your life, not have too many monetary needs now, were hoping to only tap into a small amount of it every year? Tough. That’s not your call.
So that’s one problem. It’s been there all along, only, somehow, many people didn’t really understand it.
The second problem is a bigger one, but it’s less obvious. The tables for how you will take your money out were not fixed when you contributed the money. They are revised from time to time by the government of the day. We just assumed the tax situation would be more favorable when we plan to take the money out. We assume we’ll be earning less, since we won’t be working, and we also assume the taxes will be somewhat like they are now when we’re not working. But will they be? Without a fortune teller, how are we to know?
Could, for instance, the government find themselves in a situation where they have to raise taxes, because of, oh, i don’t know, maybe a massive bailout of the financial sector? Naw, that’s not likely to happen.
So basically, we are resting a fair bit of our retirement planning on a few assumptions.
- The schedule of withdrawal rates forced on us by the RRIF plan is going to be acceptable to us when we get to retirement age.
- That the government will maintain the RRIF withdrawal tables at least somewhat like they are now.
- That taxes will remain something like they are now.
Some of those seem like pretty big assumptions. I think they need questioning. I will do more of that in another article down the road.
References: the current government RRIF tables. It depends on your age how much you take out http://www.cra-arc.gc.ca/E/pub/tp/ic78-18r6/ic78-18r6-e.html
See also taxtips.ca http://www.taxtips.ca/rrsp/rrifminimumwithdrawal.htm
Note you can play some fancy dancing if your spouse is of a significantly different age. We’ve left that complication out.