The “RRSP season” is now in full swing but it’s important to know the ins and outs of this tax-deferred plan in order to optimize the use of this account for your financial situation. You’ll notice I didn’t write “time to buy RRSPs”. You don’t buy RRSPs friends…
Today’s post will remind you about some RRSP facts, why the RRSP is a powerful savings vehicle, why you might want to take advantage of it (and what to avoid), and share our longer term game plan for this account – for what that’s worth. Happy to hear all comments and critiques!
RRSP Fast Facts for 2017
- When to contribute? The RRSP contribution deadline for the 2016 tax year is March 1, 2017. You should know this deadline is always 60 days after the end of the previous calendar year. This means RRSP contributions made in the first 60 days of 2017 can be applied to the 2016 tax year. (Note: we do this).
- Who can contribute? There is no minimum age requirement to have an RRSP; a minor can set one up thanks to their parent or legal guardian.
- How much can you contribute? Your allowable contribution room for the current tax year is the lower of 18% of your earned income from the previous year, OR, the maximum annual contribution limit. If you belong to a company pension plan however, this amount will be less due to a pension adjustment.
- What about the tax deduction? Contributions to an RRSP are tax deductible, so you can use these tax deductions to reduce your taxable income.
- What if you don’t use all the RRSP room? 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.
- What can you own inside this tax-deferred account? 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. (Note: we hold cash, ETFs and stocks).
- 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. There is a lifetime $2,000 over contribution limit before penalties apply. Any amount in excess of $2,000 contributed to the account, above the maximum, will be charged a penalty of 1% per month.
- 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).
- You can contribute to your RRSP until the end of the year you turn age 71. You can then consider converting your RRSP into a RRIF although other options are available.
RRSP Guidance for 2017
When should you contribute to an RRSP?
It depends. Some articles I read blindly tell you to contribute to this account. You should not. Although the best time to invest was yesterday; the RRSP is an excellent account for your investments – you need to invest by keeping these tax benefits for this account in mind:
- There is a tax deduction for your contribution, and
- There is tax deferred growth.
With your tax deduction, you can reduce the taxes you pay today. With tax deferred growth, investments can grow over time without being taxed as long as the money made stays in the account. For most Canadians, to reap the benefits of this tax deferred account, this means they should maximize their contributions in their highest income earning years and have a plan in place to withdrawn monies earned inside the account when they are in their lowest income earning years (likely retirement). This is because you’re not as rich as you think: when you take money out of the RRSP 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.
Should I use the RRSP for the Home Buyers’ Plan?
Probably not but that’s up to you. (Note: we never did).
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 RRSP: long-term, untouched, tax deferred growth. Withdrawals should not occur when your income is lower than the income you contributed (i.e., when you’re not working). Not smart.
Should I raid my RRSP to pay down debt?
Probably not but that’s also up to you. Generally speaking I’m not a fan of pulling money out of your RRSP to pay debt unless your alternative is taking on a substantial line of credit that will take you years to pay off.
- 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 – Remember RRSP withdrawals must show up as income on your tax return.
What is our RRSP game plan for 2017 and beyond?
Although we strive to max out our TFSAs first, every year, I still believe our RRSP accounts are an excellent wealth building tool. We’ve made RRSP contributions for years and we’ll continue to do so in 2017. Those contributions are so automatic now they don’t even show up as a savings goal for 2017.
My RRSP is maxed out now. My wife’s RRSP will be fully maxed out within another year or so. We believe maxing out our TFSAs and RRSPs will provide us with a great start to early retirement. Other than paying our mortgage the rest of our income goes to living our lives and having some fun.
Ultimately you need to consider how the RRSP can help you build wealth. Plan and choose wisely.
How are you using the RRSP this year? What’s your game plan? Got questions for our RRSP game plan?