Lesser known facts of RRSPs
When Ottawa introduced a tax-sheltered and tax-deferred investment vehicle in 1957 to encourage people to start saving for retirement, the rules were fairly simple. Since then, there has been myriad changes and, for the average Canadian, it’s pretty hard to keep up.
The more than 65 per cent of us who have invested in plans know that we save money on our taxes if we buy an RRSP. But there’s so much more to it than just the tax deduction.
Here are some lesser known facts about RRSPs:
Borrow to buy a home
If you are a first-time home buyer, you may be able to co-ordinate your RRSP strategy with the purchase of a new home. Essentially, you can borrow up to $25,000 from your RRSP (per person) to buy your first home.
Let’s say Kent is planning to buy his first house within the next 18 months. He has more than $20,000 in unused RRSP contribution room and has $20,000 saved in cash to buy a house.
If Kent puts the $20,000 into the RRSP, he will get a 36-per-cent tax savings, or $7,200. Now, Kent can turn around and not only use the $20,000 under the first-time home buyers pan but also have another $7,200 for the purchase of the home.
Related article: Buying your first home
Borrow to go back to school
Not only can an RRSP be used for retirement or to buy your first home, it can also be used to fund you or your spouse’s education under the Lifelong Learn Plan. Similar to the Home Buyer’s Plan, any withdrawals for the purpose of training or education are tax free, provided you use the government form RC96.
You can borrow up to $20,000 but you must pay it back over a period of no more than 10 years. If you do not repay, the amounts will be added to your income in the year it was due and thus taxed at the marginal tax rate.
In both the home buyer’s and the learning plans, there are lots of little rules so make sure you visit the government websitefor more information.
Related article: The lifelong learning plan
Understand withholding tax
When you put money into the RRSP, you get a tax break. But when you take money out, you have to pay the tax. When you are taking money out of an RRSP, be aware of withholding tax.
Essentially, the government says that any withdrawals less than $5,000 will be subject to a withholding tax rate of 10 per cent. For example, if you take out $4,000 from your RRSP, you will only get $3,600 because $400 (or 10 per cent) will be sent to the Canada Revenue Agency for taxes withheld at source. If you take out a lump sum between $5,000 and $15,000, you will be subject to 20-per-cent withholding and any withdrawals greater than $15,000 will be subject to 30-per-cent withholding.
The most important point to stress is that the withholding tax rate is not your marginal tax rate. Often people try to minimize withholding tax, thinking that that will be their total tax bill but they get surprised at the end of the year with additional taxes owing.
Related article: Understanding withholding tax
Defer the deduction
Most people invest in an RRSP with the intent of using the tax deduction immediately. What people don’t realize is that they can make the RRSP contribution but save the deduction for a future year.
Why would you want to do that? In case you’ll be in a higher tax bracket a year or two down the road. For example, you may be getting a big bonus that’s paid in the next year, or you may have received a severance allowance pushing your income higher.
Why not make the contribution at a later date? Because once the money is in the RRSP, you take advantage of tax-deferred investment growth.
Reduce tax deductions at source
Most people who contribute to RRSPs throughout the year wait until they file their tax return and then get a bunch of money because of the RRSP deduction.
Although that feels pretty good, what you’re actually doing is giving the government an interest-free loan with your hard-earned money. That’s pretty generous.
To avoid that, you can file a request to the Canada Revenue Agency and get less tax deducted from your paycheques. That way, your tax refund will be spread out over every paycheque and you’ll have the money more quickly to spend to reinvest.
In most cases, people contribute to their RRSPs with cash. However, if you are holding non-RRSP investments, such as Canada Savings Bonds, bonds, mutual funds or stocks, you can transfer them to your RRSP in kind or ‘as is.’
Sometimes this can be a less painful way of getting an RRSP deduction than having to come up with the cash or take out a loan. Just remember that when you transfer the investment into an RRSP, it’s considered a disposition and there may be capital gains if the value has gone up.
Use the over-contribution limit
In 1995, the government reduced the one-time over-contribution limit to $2,000 from $8,000. The limit is designed to provide a buffer in case you make a mistake in calculating your RRSP contributions.
You can use the $2,000 over-contribution to get ahead of the game and take advantage of tax-deferred growth and compounding in the RRSP. But as you get closer to retirement and withdrawals, make sure that you eventually claim the $2,000 as part of your deduction limit to avoid double taxation.
I would only add that a little-known fact about RRSP is that you can also use them to hold a mortgage – paying down a higher interest mortgage and then paying the RRSP back in fixed installments. It’s a great tool in realizing some savings that can then be invested elsewhere.
That’s a good point. Have you done that yourself?
I had 430,000 in an RRSP combined from my spouse and I . We bought a rental property with it two years ago in Alberta. I pay a annual maintenance fee to the bank of $500.00
The fees are spread out with the accounting. We had to pay CMHC no way to avoid it.
all the interest comes back to us at 4%
I haven’t myself, but I’ve helped many of my clients set them up from front to back successfully.
Let’s say I contribute a lump sum of income (after being charged income tax on it). Theoretically, down the road when I use this money to retire am I being taxed on it again?
When you contribute into RRSP, it becomes a deduction against other income and hence reduce tax payable. In this case, money in RRSP become pre-tax income, so when you take out the money in the future, it will be included as income.
There is no double taxation here.
We have 40,000 in an RRSP. Can we take some of that to put towards our mortgage without paying tax?
The simple answer is no. If you have no income in the entire year, you can take out at least the basic personal amount without paying tax. The basic personal amount can be searched over the internet.
Can you claim the $2,000 over contribution as a deduction?
First time home buyer plan limit is $25,000 not 20,000 as mentioned in the article.
Sorry Tarique, The information has been corrected. the article was originally written in 2005 and at that time, the HBP limit was only $20,000.
Tarique is 100% correct. Jim has the borrowing costs SOOOOOOOO WRONG!
Life Long Learning limit ==> 20,000 (10K per year) paid back in 15 years.
Home Owners Limit ==> 25,000 paid back in 10 years.
What happens if you withdraw funds from your RRSP and pay witholding tax greater than your marginal tax rate as calculated when you file your T4?
Example: A person has an annual income of 30,000 from dividend paying stocks (Lines 120, 121) to which a 30,000 RRSP withdrawal is added in the same tax year (Line 129). Total income is therefore 60,000 (Line 150). The RRSP was subject to 30% withholding tax or 9,000 but Income from the 30,000 from dividend paying investments ended up being reduced by Federal dividend tax credits (Line 425) and with the usual tax credits the calculations result in total taxes owing that are less than total taxes deducted (Line 437).
So in the above example you would/should get a refund – which in effect is getting some of the original witholding taxes returned … since the witholding percentage (30%) was greater than what turned out to be your marginal tax rate (lets say approx 22%).
Can you confirm such a scenario? Thanks very much.
Hello, I’m wondering if you could give me a quick answer to this:
I’m recieving a severance from my employer as my position has been abolished. I’m moving all of it to RRSP, about 40K. I’ve got the room so I thought it was my best option for tax shelter. My question is, will I be able to declare RRSP contribution tax credits on my next return? If yes, could I spread those credits over a two or three year period?
Thanks for your help.
Is it true that we have to exhaust or use first our RRSP funds before we can be eligible to GIS supplement?
Hi Mose – No, you don’t need to exhaust any RRSP or any other savings/assets before you can be eligible for GIS. What is true is that RRSP withdrawals count as income for GIS purposes, so if you are depleting them that could reduce or eliminate the amount of your entitlement to GIS.
I am 83 years old. I get both OAS and GIS.
In 2003, I had made a $ 6,500 RRSP contribution. I never used that contribution to reduce my taxes as I was always low income.
The unused RRSP contribution has always carried forward. It was withdrawn and added to my income in subsequent years. But the $ 6,500 contribution itself was never used to reduce my taxes.
Can I use it now at the age of 83, so as to reduce my net income so that my GIS goes up? I don’t get maximum GIS currently.