Monday, January 29, 2007

RRSPs: What should you do?

So, here in Canada, as every major news outlet has been sure to mention, it's RRSP season (RRSP are like 401ks), and everyone has to make sure to contribute as much as they can before the deadline. There are the typical stories of how you don't want to find yourself flipping burgers in your golden years, and bleak images of penniless seniors wasting away, alone, in decrepit retirement homes. As a result of these aggressive campaigns, people will head to their banks and financial advisors in droves and shovel money at them in the hopes that they can somehow avoid a pauper's fate. I am here to tell you today that all of this is hogwash. Pure hogwash.

Not that I think that RRSPs are a bad idea. An easy tax shelter, a giver of peace of mind, a way to squirrel away your savings so that you can't easily get at them, RRSPs are a wonderful savings tool, if used properly based on your own financial situation. However, contributing to RRSPs shouldn't be automatic. You have to think about what you want to invest in, what kind of lifestyle you want now and in the future, and how you plan on managing your account, while taking into consideration the other major socioeconomic challenges in your life (buying a house/raising children/taking care of elderly parents). Many of the people I know who opened RRSPs recently didn't even know that they had to invest in something, like you just had to put money in and the rest would take care of itself. Often, these people, when told they actually have to invest in something, get sold mutual funds with questionable returns and high MERs, or other things that may not be in the best interests of the client. So really, who gets rich off registered retirement savings programs?

In addition, everyone plays up the tax shelter advantage. Yes, there is an advantage, in that your contributions and capital gains compound tax free. But what if I want to pay my taxes now? For example, it doesn't make a lot of sense for a struggling university student to make RRSP contributions from the lowest tax bracket, the return just isn't worth it. Then, when the money is withdrawn upon retirement, it's withdrawn in a higher bracket. So, on occasion, paying into and RRSP means that you could end up paying MORE tax over the course of your lifetime. This is the case with me.

As of right now, I fall squarely in the upper-middle income tax bracket. However, I am only 30, and I am safely assuming that over the course of my career, I will in all likelihood progress well into that upper income bracket, the one where you lose about half of your income in tax. In fact, I am assuming that I will progress far enough into that bracket that when I receive my pension of 70% of the average of my five highest income years, I'll still fall into that upper income bracket. So I would contribute to an RRSP now and get 30 cents back on the dollar for the privilege of withdrawing that money in my retirement and paying 50 cents of tax on the dollar at that point. No thanks.

There is also the matter of paying off the mortgage. You won't get many financial advisors telling you to pay off your mortgage quickly instead of contributing to an RRSP. Why? Because paying off your mortgage quickly results in less money being made by the bank, while banks keep a little of every RRSP contribution you make. And guess what? Even if your investments tank, the bank still takes it's cut for managing your account, even though you lost money. I am looking to pay off a $250,000 mortgage in 7 years, instead of the standard 25. In doing so, not only is my head above water faster, but I save over $125,000, in the form of interest I don't have to pay. I don't know of any financial product that can net me that high a return in that amount of time.

I'm not saying that everyone should neglect your RRSP and run your financial advisors out of town. Just that as in all of life's challenges, you have to carefully weigh all of your options and do your research before you decide what's best. Commercials and marketing campaigns don't know who you are and what you think is important. Don't be so quick to take what the media is saying at face value, as you'll come to discover, they have interests too. Some people in my situation could look at the same factors I looked at, and decide that an RRSP is right for them. That's ok. The important part is that they did the legwork. I'm not going to tell them they're wrong if they're aware of the positives and negatives of their decision and stand by it.

Come to think of it, that's a pretty sound piece of advice for more than RRSPs: don't leave it up to someone else to make up your mind.