RRSP facts, “dos” and “don’ts” you must remember this year and beyond!
Welcome to another “RRSP season” folks!
To help you out with making any last minute contributions to your Registered Retirement Savings Plan (RRSP) before the March 1, 2019 contribution deadline, I thought I would list some of my favourite RRSP facts, “dos” and “don’ts” for today’s post.
Let me know your thoughts, as always, in a comment below!
RRSP facts and tips for this year
- You should know the March 1, 2019 RRSP deadline is just around the corner. What does that mean? March 1, 2019 is the deadline for contributing to an RRSP for the 2018 tax year.
- Are you stressed about the RRSP contribution deadline? Stop the stress. As part of your final contributions for the 2018 tax year, I encourage you to set up automatic contributions for this coming year.
- What’s your RRSP contribution limit? I know mine for the 2018 tax year was listed on my recent Canada Revenue Agency (CRA) Notice of Assessment. The answer for you might be 18% of your earned income. This includes employment income, net rental income, self-employed income and more. So, unless you’re a member of a workplace pension plan or profit sharing plan then your RRSP contribution room should be up to 18% of your earned income (not adjusted for these pensions above) to a maximum annual contribution amount.
- Is there really a maximum contribution amount? You bet. CRA keeps tabs on that too! Read on…
- The total amount you can contribute to your RRSP each year is made up of your contribution limit for the current year plus any “carry-forward” contribution room from previous years.
- Your RRSP contribution limit for 2019 is 18% of earned income you reported on your tax return in the previous year, up to a maximum of $26,500. For 2018, the upper limit was $26,230. You already know if you have a company pension plan or profit sharing plan your RRSP contribution limit is reduced. This is my case actually.
- Both your annual contribution limit and any carry-forward contribution room are shown on your notice of assessment.
Other RRSP facts and tips in any year
- An RRSP is an account, not a mutual fund or an investment itself. Please stop saying “I have to buy RRSPs!”
- Contributions to an RRSP are tax deductible, so you can use these tax deductions to reduce your taxable income.
- Some Canadians shouldn’t use an RRSP (their income may not be high enough (yet) to reap the key benefits of this account). Why do I say that???
- RRSPs are highly effective for Canadians who will be in a lower tax bracket in retirement versus their contribution years.
- There are really two great tax benefits that RRSPs provide Canadian investors:
- a tax deduction from your contribution, and
- tax-deferred growth.
- If you tend to spend your RRSP-generated tax refund every year, then maximizing contributions to your TFSAs probably makes FAR more sense.
- Contributions to an RRSP for the current tax year do not always have to be made in February – see above – every month can be “RRSP season” with automatic, monthly contributions. That’s what I do.
- There are penalties if you over-contribute to your RRSP although a small exemption exists.
- Unused RRSP contribution room can be carried forward, for future tax deductions in future tax years.
- After you select investments for the account, the income you earn on those investments inside the RRSP are tax exempt, as long as money stays in the account.
- 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) – the latter is what I do!
- If one spouse is in a different tax bracket than his/her partner, RRSP contributions can be used to lower the total amount of income taxes a couple must pay (income splitting).
- You’re not as rich as you think: when you take money out of the account, you have to pay tax. Some exceptions apply: RRSPs can be used for home purchases and education and there are programs associated with the RRSP for this. See below!
- There are rules and age restrictions when you must collapse the account.
- Withholding taxes apply to RRSP withdrawals.
- If you’re taking money out of your RRSP before you retire, you’re immediately going to pay a withholding tax (with some exceptions):
- If you take up to $5,000, you’re going to pay 10%.
- If withdrawals are between $5,000 and $15,000, the financial institution will hold back 20%.
- If you withdraw more than $15,000, 30% is held back.
- You have to report the amount you take out on your tax return as income. At that time, you may have to pay more tax on the money — on top of the withholding tax. It depends on your total income and tax situation.
Other RRSP uses?
There are two programs you can use to take money out of an RRSP without incurring taxes – but be careful!
- The Home Buyers’ Plan (HBP) allows you to 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. That’s the good news. The bad news? You’ll have to pay that back into your RRSP over the next 15 years.
- The Lifelong Learning Plan (LLP) allows you to take out 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 or your spouse’s education. You can’t use it for your child’s education – this is where RESPs come into play. You do have to pay back 10% per year for up to 10 years.
These are just some of the RRSP facts and uses you need to know!
The punchline – why RRSPs should matter to you
Again, as referenced above, there are two great tax benefits that 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.
Based on our long-term investment plans – we strive to maximize contributions to both RRSPs – mine and my wife’s. My RRSP is completely out of contribution room now. My wife’s account still has some RRSP contribution room left – and that’s part of some very lofty 2019 financial goals.
RRSP “dos” and “don’ts”
- Do use the RRSP to reduce your reduce your taxable income. If you’re in a high tax bracket, investing an in RRSP could help push you into a lower one. You’ll also receive a tax receipt based on the amount of money you contribute, which you should re-contribute.
- I would suggest (so maybe a BIG don’t from me!) to avoid using the RRSP for the Home Buyers’ Plan – which allows people to remove $25,000 from their RRSP to pay for a first home without having to pay a penalty, as long as the borrowed funds are re-invested within 15 years. With the TFSA now in place I see no reason why you should do this.
- Don’t consider the RRSP-generated tax refund as a financial windfall. It’s essentially a tax-deferred government loan to you.
- Don’t contribute to an RRSP if your earned income is less than $50,000. I think it makes far more sense to maximize contributions to your TFSA first. The TFSA is the perfect investing account or savings account for every Canadian, including those in lower tax brackets who will end up in a similar income bracket in retirement. The TFSA is also an ideal account for any investor who cannot or will not max out their RRSP contribution room.
An oldie but goodie: I’ll continue to maximize contributions to my TFSA every year because…
- I would suggest (so another don’t from me) to avoid taking any RRSP loan. That’s generally a bad idea. While a short-term loan to contribute to your RRSP might sound like a good idea – let’s face it – borrowing for investing is not generally a good idea for most of us. We’ve all seen and read the reports: Canadians are terrible at managing debt. Don’t dig yourself another hole. If you cannot afford to make regular RRSP contributions then you shouldn’t be thinking about an RRSP loan. Just me.
For many Canadians, to reap the BIG benefits of this tax-deferred account they should maximize contributions (based on their high earned income – see above); automate their contributions; keep their investment fees inside the account low; and avoid making their withdrawals for as long as possible.
What’s your take on RRSPs? Use them? Maximize contributions to them? Don’t care? I want to know.