Time to rethink RRSPs?

Is the writing on the wall for cliché RRSP-driven tax strategies? In the past, for many families it was almost a standard response that if you were in the 32% marginal tax bracket in your working years then you should definitely defer the tax by buying RRSPs. In all likelihood you would be in a similar bracket or drop to the 20% bracket in retirement. That may be about to change.

We all know that the federal government is running up massive Covid-induced debts to keep the economy on life support. Governments around the world have all reached for their cheque books in the same way. In 2019 the federal debt was about 685 billion. Some forecasters peg it approaching 900 billion by 2021. If interest rates stay on the floor then the interest expense of servicing the debt is a manageable cost but at some point, without central banks buying a lot of government bonds and “kicking the proverbial can down the road.”

Ultimately, some politicians will bow to pressure to get the debt under control. With the economy on life-support, and likely to continue so for some time, cutting government spending is not going to be the source of much improvement. At some point, the government will undoubtedly turn to taxation as a way to get the debt under control. They cannot tax the working class much without cutting the legs out from under the economy so there is a decent chance they will tax the rich. The thing is that top bracket tax rates are still pretty high and the wealthiest have ways to move their money outside Canada if things get too egregious. Thus, the taxman will likely go down-market to the upper middle class, whose money is less likely to flee Canada. That could happen in a variety of ways such as:

  • Lowering the threshold for each tax bracket so you run into a higher bracket sooner
  • Deindexing the annual reset of each tax bracket that currently lets the bracket rise with inflation
  • Eliminate exemptions like recently done with cash profits retained inside small businesses

The first two – deindexing and bracket shifting have the potential to put various taxpayers in a higher tax bracket in retirement than they are in now. This steals away the main benefit of the RRSP – putting money away for a 32% credit now and eventually taking it out for 20% taxation down the road.

While the details of the government’s tax strategy will only become apparent over time it is worth questioning the standard assumption of always putting away money in your RRSP whenever you can. In the months ahead we will be watching for signs of direction in taxation – direction that may make us rethink our response.

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