RRSP Basics

With February here already, we are now well into the annual RRSP season. This year, Canadians will have until March 3 to contribute to an RRSP and still qualify for a tax deduction in the 2013 tax year.

What is an RRSP?

Registered Retirement Savings Plans have been around since 1957. The plan is designed to help individuals save for retirement with a double tax benefit. First, contributions to an RRSP are deducted from total income on your tax return. This means that RRSP contributions will directly reduce your taxable income, with the possibility of putting you into a lower tax bracket. The second tax benefit is tax deferred growth, meaning that the money held in your RRSP is allowed to grow without immediate tax implications.

How much can I contribute?

The basic formula for calculating your RRSP contribution limit is 18% of your prior years’ earned income less any pension adjustments, to an annual maximum. You can find your contribution limit by looking at your Notice of Assessment. This is the form you get back from the CRA after you have filed your tax return. It will include any unused RRSP contribution room from the past.

Should I contribute to an RRSP?

There are a few situations where you should not contribute to an RRSP. In the vast majority of situations, however, putting money into an RRSP is a good idea. Consider the following example:

Steven’s total income for 2013 is $48,000. His marginal tax rate is 31.15% (Federal plus Ontario tax). He has been contributing $50 each week to his RRSP. For 2013 he will save $809.90 in tax, not to mention the fact that he will also have $2600 plus interest in savings. He plans to invest the $809.90 into his RRSP this year, in addition to his regular weekly contribution, resulting in a $1,062.18 tax advantage for next year.

An RRSP is a tax deferral plan. Contributing to an RRSP produces a tax advantage; withdrawing triggers a tax liability.Both the tax advantage and the tax liability are calculated at the taxpayer’s current tax rate. The ultimate tax savings occurs when an individual expects to be in a lower tax bracket when withdrawing from the RRSP.

Certain government benefits, such as the GST/HST credit and the Canada Child Tax Benefit, are indexed to an individual’s net income. Generally, the lower your income, the greater your benefit payment received. Since RRSP contributions directly reduce your net income, your RRSP contributions may very well increase your benefits under such income-indexed programs.

Funds held in an RRSP should be considered “locked in”. You can withdraw them before retirement, but generally you will pay tax on the withdrawal. The general exceptions are withdrawals under the Home Buyer’s Plan or the Lifelong Learning Plan, which specify repayment programs of 15 years and 10 years respectively.

Further Considerations

This is a busy time of year, and sometimes investors feel they need to decide on a long-term investment plan as soon as they buy their RRSP's. There are dozens of RRSP investment plans available. If you are pressed for time, simply put the money into a RRSP daily interest savings account for now so you can get the tax receipt, and then when you have done your research thoroughly you can move the money into a long-term investment plan of your choice.