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Still trying to figure out this RRSP thing? You’re not alone.
The Registered Retirement Savings Plan, known simply as the RRSP to most, is a great tool for saving money. RRSP contributions are tax deductible, which allows you to delay paying taxes on that income until you retire, when you’ll likely be in a lower tax bracket.
However, even with these tax benefits, a surprisingly low number of British Columbians take full advantage of this savings vehicle. According to Statistics Canada, only 21% of British Columbians contributed to an RRSP in 2016.
Unfortunately, our high cost of living and competing financial demands can make it challenging to put money aside. But hopefully that won’t deter you from figuring out how to make the most of what you have.
The deadline to contribute to an RRSP for the 2018 tax year is March 1, 2019.
To help you get started, I sat down with one of our Vancity wealth advisors John Vermeulen to put together this list of ways to make the most of your RRSP.
1. To contribute or not to contribute
When deciding whether or not to contribute, consider the tax savings that will come from your RRSP contributions. Every dollar you contribute to an RRSP comes off your taxable income. So, for example, if you make $60,000 and contribute $5,000 of it to an RRSP, you’ll only be taxed on $55,000 – saving you $1,410 off your tax bill for 2018.
However, saving for retirement isn’t the top financial priority for everyone.
“There are times when you may need to let retirement planning take a backseat to more urgent financial issues like dealing with debt, saving for a mortgage and planning for your family,” says John.
But keep in mind that RRSPs aren’t just for retirement. The federal government allows you to make penalty-free withdrawals to buy your first home (with the Home Buyers’ Plan) or to finance your education (with the Lifelong Learning Plan), as long as you return the money to your account over a certain period of time.
2. Know how much you can contribute
Your annual RRSP contribution limit is 18% of the earned income you reported in the previous year, up to a maximum of $26,230 for 2018.
You can find your exact RRSP contribution limit on your latest notice of assessment or reassessment, by logging into your Canada Revenue Agency (CRA) account online or by calling the CRA at 1-800-267-6999. Consider using the SecureKey Concierge service, which allows you to access your personal CRA account (along with 80 other Government of Canada websites) without having to keep track of yet another user ID and password.
The table below gives some examples of contribution limits for different levels of income.
|2017 earned income||2018 RRSP contribution limit|
And fortunately, it’s not a “use it or lose it” situation. If you don’t contribute the maximum allowable to your RRSP in any year, you can carry the unused portion forward indefinitely.
Keep in mind that if you contribute to a pension, you will likely receive a pension adjustment that will reduce your RRSP deduction limit for the following year.
3. Know your marginal tax rate
Your marginal tax rate is the tax rate that will be applied to the next dollar you earn. It depends on which tax bracket you are earning in, for both federal and provincial taxes.
Let’s look at an example based on 2018 tax rates as listed in the table below.
Combined federal and British Columbia tax brackets and tax rates
|Taxable income 2018||Tax rate 2018|
|over $39,676 up to $46,605||22.70%|
|over $46,605 up to $79,353||28.20%|
|over $79,353 up to $91,107||31.00%|
|over $91,107 up to $93,208||32.79%|
|over $93,208 up to $110,630||38.29%|
|over $110,630 up to $144,489||40.70%|
|over $144,489 up to $150,000||43.70%|
|over $150,000 up to $205,842||45.80%|
Say you earn $50,000 in taxable income in 2018:
- The first $39,676 of that will be taxed at 20.06%:
$39,676 x 20.06% = $8,173.26
- The amount over $39,676 up to $46,605, which is $6,929, will be taxed at the higher rate of 22.70%:
$6,929 x 22.70% = $1,572.88
- The amount over $46,605, which is $3,395, will be taxed at the higher rate of 28.20%:
$3,395 x 28.20% = $957.39
- Total tax: $10,703.53
By making RRSP contributions, you can reduce your taxable income in the higher tax bracket.
In this example, making an RRSP contribution of $3,395 would reduce your taxable income to $46,605, which means you wouldn’t have any income being taxed at the higher rate of 28.20%. You would save $957.39 off of your tax bill, which essentially translates to a 28.20% return on your RRSP contribution.
“If you’re making a large RRSP catch-up contribution, consider only claiming enough to reduce your taxable income in the top tax bracket,” says John. “You can carry forward the remaining deduction for greater tax savings in a future year against income that is taxed in the higher tax brackets.”
This 2018 RRSP savings calculator can help you figure out how tax savings your RRSP contribution would generate when both provincial and federal taxes are considered.
4. Make contributions regularly
A regular savings plan is one of the best moves you can make for your RRSP. It’s generally much easier to come up with $100 per month, rather than waiting until January or February to come up with $1,200.
By contributing more frequently, your money will begin working for you sooner thanks to compound growth. You can also benefit from dollar-cost averaging when you buy a fixed dollar amount of a particular investment on a regular schedule.
5. Think about a spousal RRSP
Marriage can function as a great tax shelter. The idea behind a spousal RRSP is to equalize family income, which can lead to big tax savings.
As a couple, it’s a good idea to even out the amount in your RRSPs if there’s a big disparity. You don’t want one partner to have a much larger RRSP because they may get bumped up into a higher tax bracket when they start withdrawing, costing you more money in taxes.
But what about income splitting?
“Current income-splitting rules do allow money withdrawn from a RRIF to be split with a spouse if you are 65 or older,” explains John. But these rules could change, he cautions, pointing to the federal government’s family income splitting provisions that were introduced in 2015 and then cancelled the following year. “Using a spousal RRSP is still a prudent thing to do.”
If you are married or have a common-law partner, you can contribute to a spousal RRSP for your partner and claim the tax deduction yourself. However, your total contributions to your own plan and your partner’s can’t exceed your allowable maximum contribution.
6. Name a beneficiary
One of the advantages offered by RRSPs is your ability to name someone to receive your plan value after you’re gone. Naming a beneficiary may save your estate probate fees (i.e., the cost of the legal process to validate your last will and testament). And naming certain beneficiaries may even delay them or you paying tax on the plan, until withdrawals from it are made.
Review your RRSP beneficiary regularly to make sure it matches your current wishes.
7. Consider an RRSP loan
If you’ve fallen behind in your RRSP contributions, you may want to consider an RRSP loan.
“The idea behind an RRSP loan is to borrow money to save money,” says John. “You take out a loan in order to make a large RRSP contribution, which will hopefully result in large tax savings that exceed the cost of the loan.”
While RRSP loans aren’t suitable for everyone, here are some examples of when they might be worth considering:
- you recently turned 71 and want to top up your RRSP before the December 31 deadline to close or convert your RRSPs
- you expect your taxable income to fall into a lower tax bracket next year and want to top up your RRSP while you can save more tax with your RRSP deduction
- your RRSP loan interest rate is low
- you can get a higher investment return by investing in one lump-sum in your RRSP, rather than investing gradually with smaller amounts throughout the year
- you plan to use your tax refund to repay a debt, or will contribute it to your RRSP.
8. Invest your tax refund
It’s important to remember that a tax refund is not a windfall – it’s actually your own money coming back to you, so use it wisely.
Paying down debt is usually the first financial priority for most people. If your debt is handled, you may want to get a jump on your RRSP contributions. Here are 7 smart things to do with your tax refund.
9. Watch out for big refunds
If you get a sizeable refund every year, you might be getting too much tax deducted from your paycheque.
“Ask your employer to make sure you’re contributing the right amount towards your tax deduction,” suggests John.
Then again, some folks don’t mind giving the government an interest-free loan because getting a lump sum at the end of the year allows them to save more easily than putting savings aside every month. Does that sound like you? If so, don’t sweat about changing your tax deductions – just make sure you put most of your tax refund to good use.
We recommend that you talk to your financial institution to get more specific advice. You can talk to a wealth management professional at Vancity about options relating to your situation. Not a Vancity member? Open an account today.