RRSPs at a Glance
Author: Sound Choices
January 12, 2018
The content in the below article is meant for Canadian investors only.
An RRSP can be a tax-efficient way to build your retirement savings.
A Registered Retirement Savings Plan (RRSP) is a plan that allows you to save money on a tax-deferred basis until you retire. Contributing every year can be a tax-efficient way to build your retirement savings.
Who can invest in an RRSP?
Anyone who has earned income in the previous year and filed a Canadian tax return can contribute to an RRSP up until December 31 of the year they turn 71.
How do contributions work?
The total amount you can contribute is determined by the Canada Revenue Agency (CRA) each year and is a percentage of earnings, minus any pension adjustments, plus unused contribution room from previous years.
Your pension adjustment amount is the value of any pension benefits you get from a registered plan or deferred profit-sharing plan. Your unused contribution room is the amount that wasn’t used in prior tax years, as determined by the CRA.
The maximum contribution amount may change, so check the Notice of Assessment you received from the CRA after filing your taxes. It will show your current RRSP contribution limit plus any unused room and pension adjustments. You can also visit the CRA website.
Be careful not to over-contribute. There’s a $2,000 lifetime over-contribution limit. Beyond that, you’ll pay a penalty tax of 1% per month on any over-contributions until you withdraw them from the plan.
What are the tax advantages?
RRSPs have various tax advantages compared to investing outside of a registered account. Within an RRSP, you do not have to pay tax on any income or growth that you earn. You only pay tax when you withdraw funds from your RRSP, which is hopefully when you are retired and potentially in a lower tax bracket.
You also get immediate tax savings, because you can deduct the amount of your RRSP contributions from your income on your tax return.
Viewed another way, the actual cost of your contribution is reduced because of lower taxes. The table below shows the impact a $5,000 RRSP contribution would have at different marginal tax rates.
|Marginal tax rate*||32%||39%||46%|
|Actual cost of contribution||$3,400||$3,050||$2,700|
*Source: Canada Revenue Agency. This is a hypothetical example to be used for illustrative purposes only.
You can make contributions to your RRSP throughout the year. Contributions made in the first two months of the year may be applied against either the earned income of the previous year or the current year. Contributions made between March and December are used to reduce taxable income in the year in which the contribution was made.
Why start now?
When you turn 65, you’ll receive modest pension benefits from the government, but for many Canadians, it’s not enough. According to Service Canada, the average combined Canada Pension Plan and Old Age Security benefit was just over $1,250 per person per month as of 2017. If that doesn’t sound like enough to cover your post-retirement needs, consider opening an RRSP and contributing regularly.
To learn more about the RRSP options available to you, visit AGF.com/RRSP.