A few weeks ago I was chatting about retirement planning with a teacher who was about to leave work next year with a fully funded defined benefit pension. He mentioned the recent market correction and was wondering if he should just withdraw all of his investments from his RRSP before the next crisis hits.
I tried my best to calm his fears by suggesting that even though he’s reached the standard retirement age, he was still in good health and should take a long term view of his investments rather than over-react to what the market is doing now.
What really struck me during this conversation was the fact that someone with a generous defined benefit plan was still making significant RRSP contributions. Before I moved into the public sector I was making RRSP contributions for ten years, but now I haven’t contributed for the last two years.
Should you contribute to your RRSP if you have a defined benefit or defined contribution plan?
Pension Adjustment (PA)
The primary reason for limiting your RRSP contributions when you have a pension plan is that you simply won’t have as much room to contribute. Your annual RRSP deduction limit will be reduced by the pension adjustment, or PA. This is a complex formula for defined benefit plan holders, but the end result is a significant reduction in your available RRSP contribution room each year.
Alberta teachers contribute 9.1 percent of their salary, up to the Year’s Maximum Pensionable Earnings ($48,300), and then contribute 13 percent on pensionable salary over the YMPE. So a teacher with an $80,000 annual salary would be contributing $8,516.30 each year towards their pension, or just over $700 per month.
Using the pension adjustment formula, the teacher would have their RRSP deduction limit reduced by $10,591.80 next year.
RRSP Contribution Room
Even though the pension adjustment significantly reduces your RRSP deduction limit, there is still a decent amount of RRSP contribution room left over. A salary of $80,000 would allow an RRSP deduction limit of $14,400 (18 percent). Subtracting the pension adjustment of $10,591.80 will leave this teacher with a potential RRSP contribution of $3,808.20.
The question is; should you take advantage of this contribution room each year, knowing that your retirement planning includes the luxury of a gold-plated pension?
Retirement Planning: What Are Your Options?
There are many factors to consider when planning your retirement. With a defined benefit pension you have the peace of mind knowing that you’ll be receiving 40 to 60 percent of your working salary in retirement. Whether or not you will require more income depends on the type of lifestyle you want to have in retirement.
If you also have investments within your RRSP, you will need to begin withdrawals in the year you turn 72. It’s possible that you will be earning more income in retirement than you were during your working years, meaning that you could be paying more in taxes as well.
In this case, you should consider contributing to your tax free savings account rather than maxing out your RRSP. The TFSA will give you the ability to top up your savings during your working years, and the flexibility to withdraw your investments on your own terms during retirement, tax free.