7 RRSP Planning Tips
Contributing to your RRSP is one of the most beneficial and efficient ways to both save for retirement and reduce your taxes.
RRSPs offer immediate tax relief by lowering your taxable income. There are also ways to lower how much tax your employer withholds from your pay-cheques ensuring that you do not over-pay on your income tax – which is essentially providing the government with an interest free loan for the year.
RRSPs are also designed with the objective of long-term investing. The very nature of this type of investment vehicle is such that there is great incentive to avoid “dipping” into your savings. This encourages individuals to stay invested over the long-run and reap the full benefits of market activities. Remember, the tortoise wins the race.
Any income you contribute to your RRSP is not taxable until you withdraw it from your account. This means your investments can grow on a tax-deferred basis right up until your 71st birthday and fully benefit from compound growth.
Things to keep in mind with RRSP’s
· You have 60 days after the calendar year end to make an RRSP contribution and deduct that contribution on the previous year’s tax return. This usually results in a deadline on or around March 1st
· Generally your RRSP contribution limit increases by 18 per cent of your previous year’s earned income to a specific dollar maximum.
· If you did not contribute the maximum to your RRSP each year, the contribution room not used has been carried forward and is available for use in subsequent years
· The best way to determine your RRSP contribution limit is to look at your most recent Notice of Assessment sent to you by the Canada Revenue Agency after you file your tax return each year
Without Further ado, here are 7 key tips for RRSP planning:
1.) Maximize your contribution
The less tax you pay, the more money you will have working towards your retirement goals. Your RRSP is one of the most powerful ways to protect your investments from taxes. Not only do you enjoy an immediate tax deduction, but your earnings within the plan grow and compound on a tax deferred basis until you withdraw money from the plan.
· A $10,000 RRSP contribution
· Equals $4,500 in deferred tax savings
Remember – a $10,000 RSP contribution could equal $4,500 in tax savings (if you are in the 45% tax bracket)
2.) Spousal RRSP
In 2007, the federal government introduced the ability for couples to allocate up to 50% of their ‘eligible pension income’ from one spouse to the other for taxation purposes. This is called Pension Income Splitting and it could reduce a family’s combined tax bill. “Eligible pension income” is income the qualifies for the federal Pension Income Credit and includes periodic pension income plus RRIF income where you have attained age 65.
A Spousal RRSP is an RRSP for the benefit of one spouse, but the contributions to the plan are made, and deducted, by the other spouse.
Spousal RRSPs are a good strategy if you expect one spouse to be in a lower tax bracket in retirement because they provide the benefit of balancing retirement income between spouses.
3.) Make “tax efficient” deduction decisions
You may not realize that if you expect to have a significantly higher income in the coming years, you can defer taking the tax deduction this year. Make the contribution now but take advantage by claiming the deduction when you’re in a higher tax bracket.
10,000 RRSP contribution @ 29% tax rate
$2,900 in tax savings
$10,000 RRSP contribution @ 45% tax rate
$4,500 in tax savings
4.) Go for growth
Often by playing it safe financially, you think you’ve protected yourself from investment losses. Think again. Sometimes the price of playing it safe is the erosion of your money over time thanks to inflation.
Certain investments often thought of as being safe may not keep pace with inflation, especially after considering taxes. The best way to ensure your investment stands the test of time is by investing in a diversified portfolio.
A diversified approach should include exposure to higher yielding equity mutual funds. If your portfolio is appropriately diversified and tailored to your time horizon and emotional tolerance for volatility, you will ultimately be playing it even safer over the long run.
5.) Tax-Efficient Investing
All investment income earned inside an RRSP compounds on a tax deferred basis, but once withdrawn from your RRSP it is 100% taxable. This includes realized capital gains and dividends.
• Interest income, which is earned from investments such as bank accounts, GICs and Money Market Funds is 100% taxable – the same as withdrawals paid out from your RRSP.
• Eligible Dividend income – which are profits paid out to shareholders of public corporations resident in Canada, non-Canadian controlled private corporations, and Canadian controlled private corporations subject to tax at the general corporate rate (i.e. not eligible for the small business deduction) – are tax preferred. Generally dividend income gives the best tax break if you are in the lowest federal tax bracket.
• Capital gains is the profit you receive when you sell a “capital property” such as a mutual fund for more than its cost. With capital gains you are only taxed on half of the increase in value. These are also tax-preferred.
If you have both RRSP and non-registered investments, it makes tax sense to hold your interest bearing investments inside your RRSP – since they are 100% taxable anyway – and hold investments that produce dividends and capital gains outside your RRSP. This strategy must be implemented to ensure that your overall asset allocation plan remains in place – so it’s important to discuss this with your financial Consultant.
6.) Resist “Dipping” Into your RRSP
Usually there is nothing to prevent you from accessing the investments in your RRSP (with the exception of ‘locked in’ plans). However, you should consider the consequences before you do it.
First of all, withdrawals attract tax at your marginal tax rate. Tax withholding at the time of the withdrawal may be as low as 10% but could be as high as 30%. You need to check with your tax advisor before you withdraw to determine how much more tax you’ll have to pay when you file your tax return.
Secondly, you cannot restore the contribution room. The amount that you can contribute to an RRSP in your lifetime is limited. A withdrawal erodes some of this potential.
7.) Start Early
Contribution Example
When Jim turned 22 he began investing $2,000 per year right up until the age of 30. That’s nine $2,000 installments. When he turned 30, he decided to stop contributing to his RRSP and simply let the accumulated money in his account sit untouched until retirement.
Bob on the other hand started investing when he turned 31 years old and began investing the same amount as Jim, $2,000 per year, but he continued to contribute this amount right up until retirement at age 65. That’s thirty-five $2,000 installments, nearly four times as many as Jim!
As you can see even though Jim invested only approximately a quarter of the amount Bob invested, his investment grew $26,601 more, due to the effects of compound growth.
For any questions please contact me
MARCO CONSOLI
Consultant
TORONTO, ON
email: marco.consoli@investorsgroup.com
Web page: http://www.investorsgroup.com/consult/marco.consoli/
RRSP Planning FAQ:
Question: Can I roll my Canadian RRSP plan into my US Roth plan & receive benefit of new tax law allowing IRA rollover?
I am Canadian Citizen & US resident alien living in US and want to take advantage of new 2010 tax law that allows traditional IRA rollover into a Roth, BUT want to use my RRSP Canadian retirement funds to roll into Roth. Can this be done and, if so, how?
Answer: There is no provision in US law to rollover foreign retirement accounts. You can keep the RRSP, or cash it out.
Question: Explain the difference between Canada Pension Plan (CPP) and a Registered Reitrement Savings Plan (RRSP).?
Answer: Canada Pension is a mandatory pension plan that all workers pay into. Their employers also pay a similar amount, currently a maximum of about $2000 per year per employee. Upon retirement, each person receives a pension based on the length and amount of their contributions. The pension is taxable
An RRSP, on the other hand, is your own money which is invested in whatever way YOU choose. There are a broad range of choices in plans, and one can be found for just about any investment viewpoint or desire. Money invested in an RRSP receives an immediate 100% tax deduction, and any investment earnings the plan makes are also sheltered from tax until withdrawal.
At any point, but usually on retirement, the money in the RRSP can be withdrawn in whole or in part. The money is taxable at that point.
A good retirement plan includes both CPP and RRSP funds. CPP alone will be too low to maintain any sort of lifestyle through retirement.
Question: Can over the counter stocks be invested into an RRSP self administered plan?
Answer: Exchange traded stocks can be held in a self-directed RRSP. I don’t even think an OTC is RRSP eligible anyways.
Question: Help in deciding the right RRSP plan in Canada?
I am 26 years old and planning to start RRSP. I have never had one till date. Now, I think its time for me to plan future. But, I am unsure which investor to go to. There are number of RRSP plans offered by different financial groups. I would like to know how to choose the right financial Institute, how to calculate the right amount of money I should invest for RRSP, on what basis should I decide my RRSP and any suggestion of which financial institution is good.
Answer: The maximum amount of money you can invest in an RRSP for the current year is written down in the reply to your tax return for 2008. The Canadian Tax department sends a reply like that to everyone who files a tax return.
And before you choose the financial institution for your RRSP account, you need to decide if you want to invest your money in stocks, bonds, mutual funds, and/or certificates of deposit. Some institutions are better than others in terms of fees and the investment choices they offer.
If you are not sure what type of investment you want for your RRSP. Then choose an institution with the most investment choices and the smallest service charges or fees. And then talk to a financial adviser at that institution to help you decide what type of investment is best for you.
Question: What is the difference between an RRSP and a registered pension plan?
Answer: RPP’s consist of RRSP, MPPP, IPP, & Corporate (Employer Sponsored) DC or DB plans.
RRSPs are not considered corporate/employer sponsored pension plans. As such, are a bit more lax in its regulation. For example, no funding requirements in an RRSP. By comparison, a DB Plan creates a funding liability for the Employer. But they all have the same requirements such has mandatory conversion to a RRIF/LRIF by Age 71. The funding limits vary from RRSP to IPP to DC/DB plans.
An employer could have a Group(ed) RRSP, but its really considered a collection of individual RRSPs. MPPPs, IPPs, DC/DB plans have a much stronger level of creditor protection than RRSPs.
Question: How long can I carry over my RRSP contributions without claiming them?
I’m in Ontario, Canada. I’ve been on sick leave for about 5 years, which means that I have no taxable income, but I’ve still been putting money into my RRSPs. I’m planning to claim the deductions when I start earning taxable income again, but I wondered if there’s a limit to how long I can carry the contributions over without claiming them.
Answer: You have to claim them before you reach age 71. But practically speaking you need to have qualified to contribute in each year that you have contributions. That is you can only have contributions that are $2000 above your accumulated entitlement.
This, and not the number of years would appear to limit the amount you can stash away in RRSP. You might be best to switch to the tax free savings account.
Question: Rrsp and my pay cheque?
Today was my one year anniversary with the company I work for. I received a letter saying it is required that I join an rrsp plan (with the company I assume) and they take 2% out of my pay to put into my rrsp. I don’t want it. Is this even legal? I have never heard that a company can do that and that it was required after a certain time.
Answer: I would say a good majority of large Canadian companies that have setup a corporate pension plan are setup on a Contributory basis. This is not a bad thing!!
An RPP or Group RRSP is good because the taxes withheld on your pay cheque take the G-RRSP into account, so you don’t have to wait for a tax refund in the spring of the following year.
In addition, the company may match your contribution, or even exceed it. Finally, you may find the MERs on the underlying funds lower than an Individual RRSP. 2% is not a lot, and you really should be saving a lot more for retirement anyways.
Question: Can I transfer my pension plan from my former employer into my existing RRSP?
Answer: You can transfer your former employers pension plan into a Locked-in RRSP. There is a difference between an RRSP and L-RRSP.
Although, you should consider whether its worthwhile to actually do. For example, if you are older, and you have a Defined Benefit Plan with your former employer, it may be worthwhile to keep it there as you at least know you have a certain level of income for life guaranteed with 2/3rd survivor benefits to your Spouse.