Who should contribute to an RRSP?

Hopefully, most of you know what an RRSP is. For those who don’t, RRSP stands for Registered Retirement Savings Plan and it’s one of the only tax (and largest) deduction/deferral tools that employed Canadians have. The RRSP account can be opened at any of the big banks along with some online brokerages, and allows your investment growth to compound TAX FREE. On top of that, all contributions for last year, up to March 1 of this year can be deducted from your income. This will equate to a tax return of the sum of your contributions x your marginal tax rate.

For example, if I contributed $6000 to my RRSP for 2006 (up to March 1, 2007) with a marginal tax rate of 38%, I would get a tax return of $2280 ($6000 x 38%). The tax return is free money right? Not so fast, RRSP’s are a tax DEFERRAL tool where you are taxed at your marginal rates when you WITHDRAW. So when it comes time for you to retire, hopefully you’ll be in a lower tax bracket than when you were working.

Now that we’ve gotten some of the formalities out of the way, the question that this article is going to try to answer is, who should contribute to an RRSP?

The simple answer is, anyone who is employed and expects to be in a lower tax bracket when they retire. The real power of RRSP’s though is the ability to let your investments compound TAX FREE. For example, if you were to contribute $200/month to your RRSP at the age of 20, you’d have almost $650,000 in your RRSP at the age of 60 (assuming 8% growth). If you wait until you’re 30 before you contribute, you would have $284,000 at 60. The power of time cannot be understated.

How about a new graduate from University in a low tax bracket?

Even though you are in a low tax bracket, I believe that your RRSP should be “started”. Any deductions can be carried forward to a future year when you reach a higher tax bracket. You young folks out there, take advantage of the power of time and compounding. You can also withdraw from your RRSP in the near future towards the down payment of your first home (HBP).

How about those permanent low income earners?

Low income earners who expect to stay in the same tax bracket for their career should NOT contribute to an RRSP. Reason being is that being in the lowest tax bracket will provide little tax benefits. On top of that, upon retirement, government benefits like GIS (guaranteed income supplement) may be clawed back if you have an RRSP that exceeds the maximum income requirement.

That’s all for now, comments?

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FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.
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6 years ago

Of course people who save are often higher income earners
And frugality is just as important for them especially if they cannot read the future potential of their earning ability … So my question which is rarely covered in your wonderful site is where does an rrsp fit if
You hope or plan to have a reasonably high income after 55,70 yes of age ?
Is an rrsp still a good vehicle ? And how long ? What are alternatives or plan for rrsp/other in ones estate planning when they realize their frugal approach has left them expecting a higher income after 60?
Can you help here ?

8 years ago

Disclaimer** Do NOT consider any of the following as advice in any way shape or form, as I am not communicating it as such: I’m a Financial Planner and I love how many people think RRSP’s are a big scam and how the “government takes my money!” As stated in the article, you got a tax refund up front, and don’t have to pay back the money until you withdraw… potentially many years later… you’re using the government’s money interest-free for potential profit. Most calculations will show and RRSP is usually ALWAYS better vs. non-registered. A smart move is to take the RRSP refund and pay down debt or contribute to a TFSA. I wouldn’t take a trip, buy a TV, orconsider it free money. Personally, through my employer, 100% of my stock contributions go directly RRSPs. a) I make 50% instantaneously through matching and b) If I have to withdraw it unexpectedly for any reason… well I’m just paying taxes back that I already owed anyway.

Also, improved economist, I disagree. I think what you’re trying to say is that people with higher tax rates in retirement should contribute to TFSAs. Yes, that makes sense, but flat out saying ALL should contribute to the TFSA first is not necessarily a good recommendation.

8 years ago

Having worked through the math, I would say that most people should max out their TFSA contribution before they contribute to their RRSP. RRSPs are useful for income splitting if someone earns much more or less than their spouse, but otherwise if your current income is $60,000+, you’re under age 40, and you save enough for retirement or have a company pension, you are extremely unlikely to end up in a lower tax bracket.

Most of us should be in the 22% federal + 10% provincial tax bracket in today’s $. If you make more than that, consider squirreling money away in the Cayman Islands or something of that that sort (half-joking of course) … Second, if you move to a cheaper/lower taxed jurisdiction upon retirement, you will still be paying 15% tax minimum in Canada when withdrawing from your RRSP, but nothing on money moved out of a TFSA. Finally, because we have very little competition in the banking/insurance sector (let’s hope that changes eventually) the annuities you can buy in Canada are ripping off savers. Considering all these factors, put your first $5k in a TFSA every year and only the excess of that into your RRSP.

9 years ago

<– govt worker with pension (for now)

23 yrs old, 51k… no debt. should i max out TSFA then start contributing to a RRSP?

Thanks in advance.

9 years ago

Got it! Will do! I just checked the remaining balance..looks like I
was slightly off….balance to date is $21,894….not fun. I realized
if I increase my payments to $400 it won’t make much of a difference.
I will try for $500/month. At that rate, it would take me aprox 50
months to pay. I will also try applying for repayment assistance…in
hopes to get a lower interest rate, or have the interest taken care
of. Not sure how successful that will go with my current income
bracket, but definitely worth a shot. Any other advice is greatly appreciated!

9 years ago

Hi FT!!

Ontario Student loan Current Interest Rate: 5.50 % Floating….car loan is at 1.99 %. I’m currently paying $300/month to student loan, and $308/month to car loan. Would you advise me paying more monthly to both debts? I’ve got a couple hundred dollar (aprox $300) wiggle room after other expenses like rent, gas, insurance etc. Thanks so much!!

9 years ago

Hi FT!!

I’m 23, have 20K in student loan debt, and 20K for my car. Making 43K/year. Want to ensure I’m on the right thinking page. Should not make any RRSP contributions until I have paid off my student loan and car?? Or would paying one off ie. student loan be sufficient, then make contributions to RRSP while paying down the car?


9 years ago

I have a problem with my RRSP and I don’t know where else I can post this. I have an account with Questrade (RRSP) and one of my posititons CONVERTED ORGANICS INC (COIN:US) is now declared non-eligible. I purchased the shares in February and now I am forced to transfer them out of the RRSP account or sell them? WTH? I can see that they are non-eligible now and one shouldn’t be able to buy them under the RRSP umbrella but I bought them months ago. How can CRA force me to take a loss?

Here is an excerpt from the email I got:

The Canadian Revenue Agency (CRA) determines which securities are eligible to be held in RSPs. All non-eligible securities are taxed at a rate of 1% per month, based upon the value of the security at the time it was acquired.
Your account currently holds the following non-eligible security (or securities):

To remove non-eligible securities from your RSP select one of the following options:
1. Sell the security.
2. Transfer the security to a non-registered account.

Note: transfers from a registered account (except TFSAs) are considered a plan deregistration and are subject to fees and a withholding tax.

Can anybody let me know what my best option is here? Thanks!