RRSP
The first RRSP — then called a registered retirement annuity — was created by the federal government in 1957. Back then, Canadians could contribute up to 10 per cent of their income to a maximum of $2,500. Initially these were highly restrictive accounts with rules governing investments, foreign content exclusions and where you could obtain them. All interesting information that is largely irrelevant today…unless you’re into that kind a stuff.
RRSPs have evolved over the years to be a cornerstone of many Canadians savings efforts. Effective for 2022 the maximum contribution amount is $29,210. The formula is 18% of earned income, from the preceding year to a maximum of $29,210 for 2022. The quick math is: to be able to save $29,210 you would have had to earn $162,277.78 is 2021. For 2023 the maximum contribution limit will be $30,780. With the Federal Government adjusting Personal Tax Exemptions and Benefits for inflation, presumably the maximum contribution limit for RRSPs will increase with inflation…which in 2022 will be substantial.
RRSP contribution reduce your taxable earned income on a dollar-for-dollar basis. For many savers this tax reducing benefit is the most compelling reason to make RRSP contributions. The table below will give you a sense of what the tax savings benefits will be of each RRSP dollar contribute.
Federal and Provincial tax brackets
Your taxable income places you in the following tax brackets.
|
Federal tax bracket |
Federal tax rates |
Ontario tax bracket |
Ontario tax rates |
|
$49,020 or less |
15.00% |
$45,142 or less |
5.05% |
|
$49,021 to $98,040 |
20.50% |
$45,143 to $90,287 |
9.15% |
|
$98,041 to $151,978 |
26.00% |
$90,288 to $150,000 |
11.16% |
|
$151,979 to $216,511 |
29.00% |
$150,001 to $220,000 |
12.16% |
|
More than $216,511 |
33.00% |
More than $220,000 |
13.16%% |
RRSP Carry-forward Rules allow you to defer making a contribution until such time as you either have the means to do so, or your income increases to an amount that improves the tax savings benefits. The challenge is that each year you delay contributing, you lose a year of compounded tax-sheltered investment growth. So, carefully weigh the deferral. A good financial planner should easily calculate the benefit of contributing now or awaiting a more tax beneficial income later. Is Your planner doing this? Tax-Free Savings Account (TFSA)? Maybe a lower income, tax sheltered and free savings option? See TFSA
What are the pros and cons of an RRSP:
|
Pros |
Cons |
|
1. RRSP Investments Grow Tax-Free |
1. RRSP Withdrawals are Heavily Taxed |
|
2. RRSP Contributions Reduce Your Taxable Income |
2. RRSP Withdrawals Are Not Added Back to Contribution Room |
|
3. No Withholding Tax on US Dividends within a RRSP |
3. RRSP Contribution Limit is Based on Your Income |
|
4. You Can Withdraw Money from Your RRSP To Fund Your First Down payment |
4. You Must Close Up Your RRSP By Age 71 |
|
5. RRSPs are Protected from Creditors |
5. RRSP Withdrawals Can Impact Federal Benefits |
What if you make a mistake and over-contribute to your RRSP above your allowable amount? The penalty for RRSP over-contributions is 1 per cent per month for each month you are over the limit. CRA does allow a $2,000 grace amount for over-contributions. However, that amount is not tax deductible.
The difficulty with RRSPs is not the savings benefits. The difficulty with RRSPs comes after. The moment when you convert your RRSP to a Registered Retirement Income Fund (RRIF). The Government sets the percentage of your RRIF that must be paid out each year and it increases as you age. This is where thoughtful planning comes into play. Thinking through the consequences and making appropriate adjustments is one of the goals of Financial Planning.
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“Debt erases freedom more surely than anything else.”
– Merryn Somerset Webb