Optimizing your RRSP strategy according to your career stage

           

With tax season approaching again, Canadian physicians need to think about strategies for optimizing their use of registered retirement savings plans (RRSPs). As you may know, an RRSP is an investment vehicle that allows contributions to be deducted from taxable income, up to certain limits.

It might seem that seizing any tax deduction opportunity would be a “no-brainer.” But the RRSP rules are complicated, and the best strategy depends a lot on your marginal tax rate as you progress in your career, as well as on other personal circumstances. That’s because contributing to RRSPs won’t allow you to avoid taxes entirely—it will, however, allow you to defer them.

Understanding your marginal tax rate is critical to effective financial planning over your lifetime. Under Canada’s progressive system of taxation, the percentage tax that you pay increases as your taxable income increases. For 2018 for example, the federal tax rate is 15% on the first $45,605 of taxable income, 20.5% on the next $46,603, etc. (You’ll also pay provincial or territorial tax.)

Below are some examples of how your RRSP strategy could change over your career.

Medical student

As a medical student, you probably have little or no taxable income, so any tax deduction you might qualify for by making RRSP contributions would likely generate a small refund.

If you do have money available to contribute to a savings plan, a possible strategy would be to invest instead in a tax-free savings account (TFSA). You won’t get a tax deduction on the amount you contribute to a TFSA. But you can withdraw the funds tax free later, when your marginal tax rate is much higher or as your investment goals change to reflect new circumstances such as starting a family.

If you do want to start building your RRSP account, you can also contribute to it this year and claim the deduction in a future year.

Resident

At this point in your career, you’ve begun to earn some income, but your marginal tax rate is still low compared with rates you’ll pay later as a practising physician. You can contribute to either an RRSP or a TFSA, or to both. You can also contribute to an RRSP now and claim the deduction later, when your income is higher.

One reason that you might want to start building an RRSP now is that you can withdraw funds from that investment vehicle (within limits) to help you buy your first home or to continue your education. Either way, RRSPs can be a great vehicle and a way to learn about markets as you start out in your career.

Practising physician

As a practising physician, you have a higher income than you did earlier in your life, and your personal situation is likely more complex. For one thing, you may have chosen to incorporate, in which case you’ll need to consider whether to take your compensation as salary, dividends or a combination of both. And your strategy will likely be based on your cash flow.

An accountant can advise you on the optimal amount of salary to draw as well as the potential for using RRSPs to mitigate the impact of passive income rules. You should also consider contributing to a spousal RRSP if your spouse is in a lower tax bracket than you are.

Retired physician

At this stage, your marginal tax rate may have declined, and after age 71 you’ll have to start converting funds from your RRSPs into a registered retirement income fund (RRIF) or annuities. But you can still keep contributing until the end of the year that you turn 71, as long as you have contribution room available. Moreover, you can contribute to a spousal RRSP as long as your spouse is younger than 72 and you have room to contribute.

Whatever stage of life you’re at, however, RRSPs are great vehicles for deferring taxes—and for making sure you’re well prepared for a future beyond your income-earning years. It pays to take advantage of this opportune way to invest!

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