How RRSP tax deductions work and how to save more on your next return.

                       

When it comes to planning for retirement, your RRSP (Registered Retirement Savings Plan) is more than just a savings account — it’s a powerful tool to help you reduce your taxable income and boost your tax refund. 

We spoke with Josephine Machira, a wealth advisor at Vancity and Aviso Wealth, to demystify RRSP tax deductions and share tips on maximizing their benefits.

What are RRSP tax deductions?

At its core, contributing to an RRSP allows you to lower your taxable income, which lets you keep more of your money in your pocket. 

Josephine explains that “if for the calendar year, you earned an income of $80,000 and your CRA notice of assessment shows you can contribute $10,000 into an RRSP, contributing that amount means CRA will only tax you on $70,000. This is to encourage Canadian residents to save for retirement or save for the purpose of buying a home with the intent of using the 1st time Home Buyers’ Program.”

This reduction can significantly impact how much tax you owe and, depending on your situation, could put you into a lower tax bracket. 

Ever wondered about the difference between a deduction and a credit? You’re not alone. – Josephine Machira, wealth advisor

The difference between RRSP tax deductions and tax credits.

Ever wondered about the difference between a deduction and a credit? You’re not alone. 

Josephine breaks it down, “an RRSP contribution is a tax deduction that reduces your taxable income. A tax credit, on the other hand, reduces the amount of tax you owe. For example, after your taxable income is calculated and reduced by your RRSP contributions, eligible tax credits are then applied to further lower your tax bill.”

How to maximize your RRSP contributions using tools like a retirement calculator.

Your financial situation is unique to you. So, how much is right for you to contribute to your RRSPs is going to be a personal decision. But there are tools out there to help you decide, like a free consultation with a Vancity wealth professional.

Josephine also recommends speaking with an advisor about your financial goals. “Speak to an advisor to determine your goals. You can also use tools like income tax calculators to estimate the impact of your contribution. For instance, TurboTax’s Income Tax Calculator is a simple tool that helps you understand potential refunds or taxes owed.”

You can also use Vancity’s free Retirement Calculator to plan how your savings could grow over time.

A common RRSP misconception and why you don’t need to worry.

Some people may hesitate to contribute to RRSPs because they fear having to pay a hefty bill on their future taxes. 

Josephine tells us that when it comes to RRSPs, “a common misconception about contributing to RRSPs is that there’s no benefit to do so since the CRA will tax you when you eventually withdraw the funds in retirement. But during your working years, you’re likely in a higher tax bracket than in retirement. This means you’re likely taxed less on withdrawals in the future and the withdrawals can be spread out over many years.”

Life happens. Sometimes, you may need to withdraw from your RRSP before retirement. But what do you need to know before you do so?

Plus, contributions grow tax-deferred, letting your investments compound over time without immediate tax implications. That means the sooner you contribute, the more your money can grow for your retirement. 

What about early withdrawals?

Life happens. Sometimes, you may need to withdraw from your RRSP before retirement. But what do you need to know before you do so?

Josephine highlights two key considerations:

Tax Implications and RRSP withholding tax:
When you withdraw funds from an RRSP, the government takes a portion of it upfront as an RRSP withholding tax. 

“Withdrawals are subject to withholding tax: 10% for amounts up to $5,000, 20% for $5,000.01 to $15,000, and 30% for over $15,000. However, your total income for the year will determine your final tax obligation when you file.”

Think of RRSP withholding tax as a prepayment for the income taxes you’ll owe on your RRSPs. 

Times when it may make sense to withdraw early:
There are certain situations where it may make sense to withdraw your RRSPs early. “Early withdrawals might make sense if your income is temporarily low. For example, I’ve had members on medical leave who withdrew RRSP funds during low-income years to minimize taxes.”

It’s important to speak to an advisor to determine the best plan of action if you’re considering withdrawing your RRSPs early. 

Don’t overlook spousal RRSPs.

For couples with income discrepancies, spousal RRSPs can be a game-changer. 

Josephine explains that “a higher-earning spouse can contribute to a spousal RRSP in their partner’s name and claim the tax deduction. This way, when the lower-income spouse withdraws funds in retirement, they’re taxed at their lower rate.” 

By spreading out the income and using the lower tax rate, couples can achieve a lower tax bill. It’s like teamwork for tax savings. 

One of the most frequent missteps people make is not knowing their RRSP contribution deadline.

The value of starting early.

Even if you plan your finances carefully, life has a funny way of throwing a wrench in your plans. But the best way to deal with life’s curve balls is to be prepared early on. 

Josephine has a powerful story that underscores the importance of saving. “I know of a member who started saving in her RRSPs in her 20s as she did not need access to the funds for the long run. Years later, when she faced the challenge of supporting her daughter through rehab, those funds allowed her to take time off to be with her daughter and cover some of the costs that came with it. Starting early doesn’t just prepare you for retirement — it prepares you for life’s unexpected turns.”

Common mistakes to avoid, like not knowing your RRSP contribution deadline.

One of the most frequent missteps people make is not knowing their RRSP contribution deadline. Typically, 60 days into the new year, your RRSP contribution deadline marks the cutoff for contributions that can be deducted on your previous year’s tax return. Missing this deadline means you lose the opportunity to maximize your tax savings for that year, potentially leaving money on the table.

Another error to avoid is not knowing your RRSP room. If you contribute more (or less) than your actual limit, you may end up with penalties or missed opportunities. Josephine advises checking your CRA notice of assessment to stay on top of your contribution limit and avoid costly mistakes. “Your notice of assessment lays out your room clearly, so make a habit of reviewing it each year,” she says.

“You don’t need to max out your contribution room all at once,” Josephine emphasizes. “Start with what you can afford. Small, consistent contributions may grow significantly over time.”

Finally, skipping contributions altogether is a trap many fall into, particularly when faced with financial constraints or competing priorities. But Josephine reminds us that even small, consistent contributions can grow significantly over time thanks to the power of compound growth. “You don’t need to max out your contribution room all at once,” Josephine emphasizes. “Start with what you can afford. Small, consistent contributions may grow significantly over time.”

Take control of your RRSP strategy.

Maximizing your RRSP contributions is a smart move for your financial future, and Vancity is here to help. For personalized guidance, book an appointment with an advisor today.

Mutual funds other securities are offered through Aviso Wealth, a division of Aviso Financial Inc. The information contained in this article was obtained from sources believed to be reliable; however, we cannot guarantee that it is accurate or complete. This material is for informational and educational purposes, and it is not intended to provide specific advice including, without, investment, financial, tax or similar matters. Using borrowed money to finance the purchase of securities involves greater risk than purchasing using cash resources only. If you borrow money to purchase securities, your responsibility to repay the loan and pay interest as required by its terms remains the same even if the value of the securities purchased declines. Please see our Terms of Use.

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