With “RRSP season” now in full swing I thought I would remind you about some RRSP facts, why the RRSP is a powerful savings vehicle, why you might want to take advantage of it (or not), what to avoid when it comes to this account, and share what our longer term game plan for this account is.
First up, RRSP facts this year
- The RRSP contribution deadline for the 2015 tax year is coming up – February 29th.
- Contributions to an RRSP are tax deductible, so you can use these tax deductions to reduce your taxable income.
- There is no minimum age requirement to have an RRSP; a minor can set one up thanks to their parent or legal guardian.
- Contribution limits are based on the contributor’s earned income and can be found on his/her tax notice of assessment. The contribution room to this account is based on 18% of your earned income from the previous year up to a maximum of $24,930 for the 2015 tax year. (That’s a good chunk of change to sock away for your financial future). If you belong to a company pension plan, this amount will be less.
- If you did not use all of your RRSP contribution room from some previous years you can carry forward the unused room indefinitely. Check out your current Notice of Assessment to learn about your contribution room.
- You can contribute to your RRSP until the end of the year you turn age 71.
- Inside an RRSP you can hold a variety of investments including Guaranteed Investment Certificates (GICs), mutual funds, Exchange Traded Funds (ETFs), stocks, bonds, and other securities.
- An RRSP is an account, not a mutual fund or an investment itself.
- There are penalties if you over-contribute to your RRSP although a small exemption exists.
- All money inside this account including the money you earn on your investments is tax deferred.
- A common type of RRSP is an individual RRSP, registered in the name of the person contributing to it. There are also spousal RRSPs and group RRSPs.
- RRSPs can be managed by a professional money manager but you can do-it-yourself (self-directed).
When should you contribute to an RRSP?
It depends. Some articles I read blindly tell you to contribute to this account. Don’t follow that advice. As referenced above, there are two great tax benefits RRSPs provide Canadian investors:
- a tax deduction from your contribution, and
- Tax deferred growth.
With your tax deduction, you can reduce the taxes you pay today. With tax deferred growth, investments in your RRSP can compound over time without being taxed as long as money made stays in the account.
For most Canadians, to reap the benefits of this tax deferred account they should maximize their contributions when it makes sense (based on their earned income) and keep the fees associated with their investments inside the account as low as possible for as long as possible. This means RRSPs are highly effective for Canadians who will be in a lower tax bracket in retirement versus their contribution years. This is because you’re not as rich as you think: when you take money out of the account, you have to pay the tax on the money withdrawn.
If you’re in a low tax bracket today or you’re just starting your working career*, you might want to think about maxing out your Tax Free Savings Account (TFSA) first, killing off all personal debt, creating an emergency fund or a combination of all three before you contribute to an RRSP.
*One caveat I’ll add to my guidance above is if you work for an organization that offers an RRSP matching program – then by all means take the free money offered by your company who will contribute to your RRSP and get the investments you choose inside this account working for you.
Should I use the RRSP for the Home Buyers’ Plan?
Probably not but that’s up to you. The Home Buyers’ Plan (HBP) is a program that allows you to withdraw up to $25,000 in a calendar year from your registered retirement savings plans (RRSPs) to buy or build a qualifying home for yourself or for a related person with a disability. There are a few conditions to take advantage of this plan. You can read more about the HBP from our government’s website here.
In a nutshell you can repay the amount withdrawn within 15 years and you can repay the full amount back into your RRSP at any time. I personally don’t think the HBP is a great deal:
- Problem #1 – You’ve received a tax refund on the money contributed to the RRSP. You will not receive another tax refund when you put the money back.
- Problem #2 – While you have up to 15 years to pay back the loan, you might be in a higher tax/income bracket when you do. Effectively you are in conflict with a couple of core benefits of the RRSP account: long-term, untouched, tax deferred growth, and withdrawals that should occur when your income is lower than the income you contributed (i.e., when you’re not working).
Should I raid my RRSP to pay down debt?
Probably not but that’s also up to you. Generally speaking, unless you have a big emergency on your hands, pulling money out of your RRSP to kill debt is a bad idea for a couple of reasons:
- Problem #1 – There are withholding taxes charged if you raid this account early, think of it as a penalty charged by your future self.
|RRSP Withdrawal Amount||Withholding Tax|
|Up to $5,000||10% (5% in Quebec)|
|$5,001 to $15,000||20% (10% in Quebec)|
|$15,001 +||30% (15% in Quebec)|
- Problem #2 – Any money withdrawn must show up as income on your tax return. Ouch.
What is our RRSP game plan?
Overall I believe this account can be an excellent wealth building tool if used wisely: the contributions you make today lower your taxable income and you get a tax refund because of it. A great formula! However, be reminded once again the RRSP-generated tax refund is really a government loan – at some point you’ll have to pay that money in whole or in part back.
We’ve contributed to our RRSPs for years and will continue to do so. In recent years, we’ve strived to increase contributions to these accounts as we approach our peak-income earning years. We also have many other demands for our income that include maxing our TFSAs every year, paying down mortgage debt and last but not least – just living our lives and having some fun.
Ultimately, you need to consider the same thing this RRSP season (and every RRSP season) – how best to use this account as part of your balancing act to secure your family’s financial future. Choose wisely.