RRSP: Should professionals use it to save?
Unlike most Canadians who are not operating a business, many professionals have more options to them when it comes to retirement savings. The average Canadians employed by companies in the private sector will typically use the Registered Retirement Savings Plan (RRSP) or the Tax–Free Savings Account (TFSA). The lucky few work for organizations that sponsor a registered pension plan, but their numbers seem to be declining every year as a percentage of the workforce not working in para–public employment.
Both the RRSP and TFSA have much in their favour. Since 1957, RRSP savers can claim tax deductions allowing them to defer paying tax on earned income. Since 2009, those who contribute to TFSAs can accumulate savings that will not be taxed along the way, nor once the funds are withdrawn in retirement. As a bonus, TFSA income is deemed not to be “income” when it comes to social programs relating to retirement such as the Old Age Security pension and the Guaranteed Income Supplement (whereas receipt of RRSP income in retirement has the effect of “clawing back” these social programs—in effect, penalizing those who dutifully saved on their own.)
Most Professionals now have the ability to mimic what their in–house government colleagues enjoy, by establishing their own personal pension plans, but only if they carry out their profession through a professional corporation (PC). The Income Tax Act (Canada) will only allow pension plans where there is a bona fide employment relationship, such as when an PC receives partnership draw from the firm in which it is a partner, and subsequently pays a salary (or bonus) to its employee, the actual professional.
Most Canadians believe that a pension plan is “equivalent” to an RRSP when it comes to tax–assisted savings plans provided by the government. Nothing is further from the truth. In actual fact, there are seven additional tax deductions available to a PC and its professional/employee under a pension plan that simply do not exist under RRSP rules. We detail them below in broad strokes:
- Every year, assuming that employment income paid by the PC exceeds $145,722.22, the tax–deductible contribution to the pension plan will be higher than the maximum permitted for RRSP (currently capped at $26,010.00). This excess pension gap can reach above $17,000.00 around age 64 to age 71.
- Unlike with RRSPs, all investment management fees are tax deductible to the PC.
- If the assets of the pension plan fail to keep up with the prescribed assumed growth rate of 7.5%, the PC will be able to make additional corporate tax deductions called special payments.
- If the professional received employment income from the PC in the past, the PC can often make a large, lump sum, tax–deductible contribution to purchase “past service”.
- If the PC needs to borrow money in order to contribute to the pension plan, the interest paid to a lender is corporately tax–deductible.
- If the professional decided to retire prior to age 65, the PC could “upgrade” the basic pension with additional payments (early retirement subsidy and temporary CPP bridge pension), the cost of which would be borne by the PC and therefore tax-deductible in its hands.
- In the year that the pension plan is set up, the professional would be entitled to also make an RRSP contribution in addition to the corporate tax deduction made by the PC.
It is easy to see that the contributions made to a pension plan dwarf those permitted under RRSP rules, which translates into significantly higher levels of registered assets compounding in a tax–deferred environment for numerous years. Moreover, the taxes that the PC would have had to pay can now be retained for other uses (purchasing insurance, paying dividends, re–investing etc.)
While the RRSP cannot compete with the pension rules when it comes to tax–assistance, they are more flexible when it comes to withdrawing money. An RRSP can be collapsed at any time, and its assets made available for immediate consumption (net of any withholding tax imposed by the financial institution). Pension plans do allow for some of the funds to be accessible immediately, but provincial locking-in rules in certain provinces like Ontario make it much harder to access some of the assets in the plan. Therefore, professionals who see their RRSP as a glorified savings account should stay clear of personal pension plans.