RRSPs - Top 8 FAQs
It’s that time of the year again where your T4s are starting to roll in and you have to start thinking about RRSPs. How much to put in? How much room do I have? What’s the benefit of me doing this again?
We’re going to tackle the top 8 FAQs about RRSPs so that you can make the right decision easily this year.
How much should I contribute to my RRSP?
There’s no magic number of how much you should contribute. You should first look at how much (if any) tax you owe. It’s usually a good idea to put enough RRSPs in to offset paying any taxes. Most people aim to contribute enough so that when they retire, they can maintain a similar lifestyle to what they currently enjoy. Most experts suggest you’ll need 50 to 70 per cent of your current income per year while in retirement.
The maximum you can contribute to your RRSP each year is 18 per cent of your income up to a limit (the ceiling for 2018 is $26,230). If you’re maxing out each year then you’re doing great. You should make sure you update your retirement plan to make sure you’re not ever contributing to your RRSP. In specific circumstances you can actually over contribute and there won’t be much of a benefit in pulling the money out later. Talk to your Financial Advisor. Realistically though, contributing 10 per cent of your pre-tax income each year is a good target, especially if you’re carrying debt.
Will I lose my RRSP contribution room if I don’t put any money in this year?
No, if you have RRSP contribution room this year but can’t use it all, you can carry it forward indefinitely. Your Notice of Assessment will show you this year’s contribution room, plus any unused amounts carried forward from previous years.
Do I have to deduct my RRSP contribution on this year’s tax return?
No. In some cases, you probably shouldn’t. Many people don’t know there are two different things: RRSP contribution and your RRSP deduction. Both have their place and sometimes your RRSP deduction can wait.
So Why wait? Most people anticipate their income, and therefore their tax bracket, increasing in the future. When you file your tax return, your RRSP contribution is deducted from your taxable income. Your income level and tax rate is how you determine how much you’ll get back.
So if it makes sense to contribute enough so you don’t have to pay extra taxes then you’re good. But if you think you’r going to be in a higher tax bracket in the future then be sure to hold off on your deduction, at least part of it. Then in the future when you’re in a higher tax bracket, you will receive a greater benefit from your deductions.
Why does it seem like I have so little RRSP room to work with?
This is because you simply didn’t make a lot of income this year or you’re in a really good pension plan, possibly offered through your employer. If you do have a pension plan offered through your employer, take a look at your Pension Adjustment (PA) — a number that reflects the value of the pension benefits you’ve built up in the company plan.
Your employer is required to calculate your PA and report it to the CRA for your T4 each year. The CRA then takes 18 per cent of your earned income for the year (up to the maximum limit) and reduces it by your PA.
Thus, a PA will reduce your annual RRSP contribution limit since you’re already earning some sort of retirement benefits at work.
If I don’t make much income, does an RRSP contribution still make sense?
This is the largest misconception when it comes to RRSPs. If you fall in the lowest tax bracket then there are no tax savings. In fact, many low-income Canadians will actually gain less than they think from making RRSP contributions, particularly as they get older.
For instance, those who expect to receive the federal Guaranteed Income Supplement (GIS) when they retire should probably think twice about RRSPs.
GIS is currently available to Canadians earning less than $18,240 per year, and for couples with joint incomes under $24,096 (if your spouse/common-law partner receives the full Old Age Security pension).However, extra income from RRSPs counts against GIS, as it adds to your total income. The amount you receive from GIS would be reduced by 50 cents for every dollar of retirement income above the threshold.
The main benefit of RRSPs is that you contribute now while you’re in a higher tax bracket and receive a tax deduction. When you go to pull out that money in retirement you still have to pay the taxes, but for most Canadians you will be in a lower tax bracket. For example, you contributed when your tax bracket was 30% and now you pull out the money in retirement when your tax bracket is 15%. You saved yourself 15%.
Should I borrow to maximize my RRSP contribution?
It depends. The actual math is complicated but when you factor in projected rates of return, the tax breaks, and the cost of starting late, some people might be better off borrowing to make a contribution.
If you don’t have enough cash on hand to jump in before the deadline, many financial institutions will structure a special RRSP loan with no payments for the first couple of months to allow time for you to get your tax refund before you have to start making loan payments.
Unlike interest on money borrowed to invest, interest on money borrowed for RRSP purposes isn’t deductible. But contributing will generate a tax refund, which in turn could be used to pay down the amount you borrowed.
To figure out if this route is really for you, you should first estimate the rate of return on your RRSP. If it is higher than your loan interest rate, then borrowing money to use towards RRSP contributions does make sense. Make sure you can comfortably handle the payments though. Remember: Your loan interest rate should be at least two per cent below your expected RRSP return and your loan term probably no more than five years.
What if my spouse takes money out of our spousal RRSP?
If one of you made little to no income this year, then a withdrawal may make sense. When you make less income, you are in a lower tax bracket and your withdrawal subsequently won’t be taxed as much. You may now even want to invest that money outside the RRSP.
Withdrawals from a spousal RRSP have to be declared as income by the spouse or partner who is the holder of the plan. However, if you contributed to any type of spousal RRSP two years prior to the withdrawal — even if it wasn’t the particular spousal plan from which the funds are being withdrawn — you’ll have to declare the amounts withdrawn on your own tax return by your spouse and pay tax on them as well.
This rule doesn’t apply though if you and your spouse are separated and living apart when the withdrawal occurs.
How much tax will be withheld if I take some money out of my RRSP?
All financial institutions are required by the CRA to charge applicable withholding taxes on lump sum retirement withdrawals in the same year, unless you’re transferring the money to an RRIF or an annuity, taking advantage of the Home Buyer’s Plan or The Lifelong Learning Plan. Right off the top they take 10 per cent charge on the first $5,000, 20 per cent on amounts between $5,000 and $15,000, and 30 per cent on amounts over $15,000.
This is not your total tax liability though; it’s just a down payment on what you owe. The money you withdraw is also added on to all of your other income, which may result in another tax bite the following April.
At the same time, realize that you’re never going to get all your money up front no matter what you do. So will you be taxed eventually.
There’s some homework that needs to be done if you want to understand everything about RRSPs but knowing the answers above will help you make an easy decision on how much to put into your RRSPs this year.
The deadline for 2018 contributions is March 1, 2019.
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