It's that time again when Canadians go out and buy RRSPs for the past year. Here's a comprehensive resource to help you make good RRSP decisions this year.
Who is eligible to buy RRSPs?
Anyone who has earned income, has a social insurance number and has filed a tax return can contribute to an RRSP up until December 31 of the year they turn 71. After this age if you continue to have earned income, you can contribute to a Spousal RRSP up until December 31 of the year your spouse turns 71.
There’s lots of debate over whether your should buy Registered Retirement Savings Plans or not. Here’s my one formula approach to figuring out whether they make sense for you. The proper use of RRSPs: the one formula approach.
Maximum contribution limits
Your allowable RRSP contribution for the current year is the lower of:
- 18% of your earned income from the previous year, or
- The maximum annual contribution limit (See chart) for the taxation year less
- Any company sponsored pension plan contributions (PA – pension adjustment)
|Tax Year||Income from||RRSP Maximum Limit|
- A Past Service Pension Adjustment (PSPA) arises in rare instances where a member of a pension plan has benefits for a post-1989 year of service upgraded retroactively.
- Pension Adjustment (PA) represents the value of any pension benefits accruing from participation in a registered pension plan or deferred profit sharing plan.
For most people, earned income for RRSP purposes is the amount in box 14 of their T4 slips.
Earned income also includes self-employed net income, CPP/QPP disability payments and net rental income.
Income sources that do not qualify as earned income include investment income, pensions (including DPSP, RRIF, OAS, and CPP/QPP income), retiring allowances, death benefits, taxable capital gains and limited-partnership income.
Revenue Canada's Form T1023 (Calculation of Earned Income) outlines all sources of earned income.
Obtaining your contribution limit
After processing your tax return, Revenue Canada sends a Notice of Assessment, which includes your next years' contribution limit. This document also shows your unused contribution room.
Or you can call your local Tax Information Phone Systems (TIPS) number, which is found in the blue pages of your phone book under Tax Services. Be sure to have your SIN and previous tax return ready.
Related article: How much can I contribute to an RRSP?
You don't necessarily need cash to make an RRSP contribution. You can contribute (in kind) a security you already own outside your RRSP.
The “in kind' contribution is equal to the fair market value of the security when contributed. The security is deemed to have been disposed of at time of contribution. Be aware that this can have tax consequences.
Unused/carry forward contribution room
RRSP contribution room accumulated after 1990 can be carried forward to Subsequent years. If you are unable to maximize your RRSP contribution this year, you are allowed to make up the difference in later years.
The $2,000 lifetime over contribution allowance applies to those who have reached age 18 or older.
Your over contribution can be used as a deduction in future years. ($2,000 over contribution this year an be used as part of your deduction in the following year.
Any amount in excess of $2,000 will be charged a penalty of 1% per month.
Make monthly contributions
Contributing to RRSPs on a monthly basis not only makes saving for retirement easy, simple and automatic but you can also benefit from the power of Dollar Cost Averaging.
Related article: The Power of Dollar Cost Averaging
There are so many documented advantages of making regular contributions to the RRSP. Dollar cost averaging is one of the best ways to create a forced investment plan. From an investment perspective, dollar cost averaging can help you to buy more units when prices are low and less units when prices are high.
All or a portion of your RRSP contribution can be made to an RRSP in your spouses name. As the contributor, you get the deduction, but your spouse is the owner of the plan. This includes common-law spouse as defined by Revenue Canada
If you expect your spouse's retirement income to be lower than yours, then a Spousal RRSP may be the best form of future income splitting. Remember the effective use of Spousal RRSPs requires planning ahead. Don't wait until it is too late.
There can be tax implications when spousal funds are withdrawn.
More information: The proper use of Spousal RRSPs
RRSP deadline to receive a tax deduction
The deadline for a RRSP tax contribution is always 60 days after the end of the previous year to be eligible for a deduction for the 2018 tax year. This year the RRSP deadline is March 1, 2019. Consult with your financial institutions about how they are able to accommodate deadlines.
Contributions made in the first 60 days of the year can be applied against the previous taxation year or in any subsequent year.
If you are turning 71, this is the last year in which you may contribute to your RRSP. You must convert your RRSP by December 31 in the year you turn 71.
Know your marginal tax rate
One of the most important benefits of the RRSP is the tax deduction for the current tax year. While most people put money into the RRSP to save tax, many do not know how much tax they are saving. The easiest way to determine the benefit of your RRSP contribution is to know what your current marginal tax rate is when you combine the federal and provincial taxes.
Related article: Canadian Tax Brackets
Watch your tax bracket threshold
If you're making a large RRSP catch-up contribution, consider only claiming enough of the resulting deduction to reduce your taxable income in the top tax bracket. You can carry forward the remaining deduction for greater tax savings in a future year against income that is taxed in the higher tax brackets.
For example, Jessica lives in BC and makes $68,000 per year and just inherited some money and wants to put some money away for her retirement. She has approximately $60,000 of unused RRSP contribution room and is wondering if she should contribute the entire $60,000 to use up the room.
If Jessica made the entire $60,000 contribution to the RRSP and deducted the entire amount on her tax return, she would get a tax refund of about $12,375.
Another option is to use half the deduction ($30,000) this year and save the other half ($30,000) for next year. She would get a refund of about $8000 in each year for a total tax savings of $16,000.
Related article: When should you use your RRSP deduction?
What is the Home Buyers' Plan?
With the Home Buyers' Plan (HBP), you can, take up to $25,000 out of your RRSP to put towards the down payment on your first home and you won't be taxed on it. However, you do have to pay it back into your RRSP over the next 15 years.
Lifelong Learning Plan (LLP)
With the Lifelong Learning Plan (LLP), you can withdraw up to $10,000 a year, or up to $20,000 in total each time you participate in the LLP to help pay for your education. All you have to do is repay at least 10% per year for up to ten years.
Participants must start to make repayments two years after their last eligible withdrawal, or five years after the first withdrawal, depending on which due date comes first. Amounts withdrawn must be repaid within 10 years.
Investment Ideas for your RRSPs
Making good investment decisions is important to the long term growth of RRSPs. Here's a few articles providing some investment ideas as well as some timeless investing tips for your RRSP:
- Stages of investing. How you invest your Registered Retirement Savings will depend partly on what stage of investing you are at. Someone starting out will probably want to keep it simple. The more money you have, the more sophisticated you can get.
- Advantages of Self-directed RRSPs. This is one of my most popular articles. I have a self-directed account myself and think that anyone with over $50,000 in their account should consider a Self-Directed Registered Retirement Savings Plan.
- My EFT Investment Strategy. Everywhere I go, I have people asking me how I invest my own money and what kinds of things I invest in. Here's my ETF investment strategy.
- Investing Your RRSP contribution. There is no shortage of information on investing your RSPs. The problem is there is too much information. Here are 5 timeless tips when it comes to investing.
- Spouses should work together when investing RRSPs. The investment industry leads couples to manage their portfolios separately but there are times when couples are better off working together in developing an investment strategy for Registered Retirement Savings Plans.
RRSP and Estate planning
One of the areas not talked about as much regarding RRSPs are the estate planning aspects of RRSP decisions. Here are a few things to think about when choosing beneficiaries and understanding tax implications at death
- What happens to your RRSPs when you die? Here’s a topic we don’t like to talk about but it’s really important to know the answer to this question.
- RRSP and RRIF Tax Trap. By not paying attention to the beneficiary of your Registered Retirement Savings Plans, your beneficiaries might find themselves in a tax trap.
- Don’t die with too much money in your RRSPs. Most people don’t realize that tax deferral is great but only to a point. Trust me when I say the last thing you want is to die with too much RSPs. The tax hit is not what you want.
- Designating Beneficiaries. One of the decisions that needs to be made when you buy or open up a Registered Retirement Savings Plan is you need to pick a beneficiary. Before you do, you should consider the tax implications.
RRSPs and retirement
Not only is it important to contribute and grow your RRSPs, it's also important to understand the decumulation aspects of RRSPs. Here's some information on what do to with your RRSPs when you retire:
- Withdrawing money from your RRSPs in retirement. When you retire you need to make some decisions about your registered money. Here are 4 options to convert your retirement plans to income.
- Converting RRSPs to Income. This is one of the first articles I wrote on converting RRSPs to income and it’s still relevant. Check it out for some great timeless tips on converting to RRIFs or annuities.
- Everything you need to know about RRIFs. When people need to draw an income from their registered plans, they typically choose an RRIF. Here’s what you need to know about RRIFs.
- Everything you need to know about life annuities. The alternative to the RRIF is a life annuity. Here are some things you need to know about life annuities.
Get help if needed
The investment industry has come a long way and there are more opportunities for the do-it-yourself investor than ever before. You can open up a trading account and start investing in stocks, mutual funds or Exchange Traded Funds.
If you are not the do-it-yourself type and need help, the traditional strategy is to go to a bank or seek help from a financial advisor for all your RRSP decisions.
The investment industry has grown and advanced and today there are more options than ever. Today, many people are looking at alternative ways of getting help and one of those ways is through Robo-Advisors.
Related article: Battle of the Best Robo Advisors in Canada
Good luck with all your RRSP decisions. Hopefully this list of RRSP tips gets you going in the right direction.