RRSPs: a primer, plus a strategy

With the new year comes new deadlines, and one of the deadlines coming up soon is the RRSP contribution deadline, on March 1st, 2018. Today, we’d like to talk a little bit about the RRSP, as it’s one of many strategies that we help our friends and clients incorporate into their financial plan. At It’s About You Financial, we’ve noticed that many people love the RRSP. Many people even have an RRSP already. However, not that many people actually fully understand their RRSP, or even what investments they’re holding in there, if any. Today, let’s learn a little bit about the RRSP, and also one simple but effective strategy to help you increase your savings.

The RRSP is a “registered retirement savings plan” which offers 2 tax benefits: tax deduction and tax sheltering. This means that if someone contributes $5,000 to their RRSP, and they made $50,000 gross income that year, their taxable income will drop down $45,000. Every dollar of RRSP contribution is eligible for tax deduction. Furthermore, once your money is inside an RRSP account, it is tax sheltered. This means that any growth inside an RRSP does not get taxed until you choose to make a withdrawal. Note that this is very different from a regular, non-registered investment which gets taxed regularly.

The amount of taxes you save is based on your marginal tax rate. In Canada, the more money we earn, the higher percentage we have to pay in taxes. Take a look at an example of the federal tax rates here. So, what does this have to do with your RRSP contributions? If a person contributes $5,000 while he has a 20% marginal tax rate, he would get back $5,000 x 20% = $1,000. If the contribution was made in a year where he had a 40% marginal tax rate, he would get back $5,000 x 40% = $2,000, effectively doubling his benefit.

What does the RRSP deadline mean? The RRSP deadline on March 1st, 2018 is the deadline for which contributions will be calculated towards your 2017 tax year. Why is this important? Well, following from the previous point regarding actual tax dollars saved, if someone has a really good year where they’ve earned a lot of income, they may want to specifically apply their tax deduction to the 2017 year in order to get the largest tax benefit.

Now, one strategy you may want to consider is accumulating your RRSP contribution room for later years. One thing in particular we should note about the RRSP is that there’s a certain amount of contribution room. Many people, especially those who like to save, try to max out their annual RRSP contributions. Usually this is a disciplined and committed strategy, and people should be commended for it. However, there are some people for whom maxing out their RRSP is NOT the best strategy, especially for those who are self-employed.

For people who have varying levels of income, or flexible income on an annual basis, you could make your RRSP tax deduction much more effective if you put more money into an RRSP during the high-earning years. This strategy is also very effective for people who get regularly increases in salary.

In the meantime, however, what should you do with the money that you’re not putting into an RRSP yet? Our advice? Keep on reading in the following weeks, where we will be discussing some advanced strategies that can work even better for you than the RRSP. Once you have all the information, you’ll be able to come to a great conclusion as to what choice is the best for you. Stay tuned!