Getting those few extra dollars into your RRSP will help you save on taxes and benefit from tax-deferred investment growth.
Tax benefits of your RRSP contributions
“Contributing to an RRSP allows you to deduct the contribution amount from your taxable income and provides tax-deferred growth on the investments in the RRSP,” said ATB Wealth Senior Solutions Analyst of Financial Planning, Linda Lamarche.
“A lower taxable income results in a decreased tax bill, or an increased tax refund, for the year of contribution.”
In addition to lowering the amount of tax you’ll owe on this year's earnings, any earnings you make on your investments will also be tax deferred.
You can calculate your estimated tax savings based on your RRSP contributions. First, determine your tax rate by looking at your income and provincial rates. Then multiply your total contribution for the year by that tax rate and you will have an approximate RRSP tax refund. ATB Financial also offers an RRSP calculator.
RRSP contribution deadline
The Government of Canada will allow you to contribute to your RRSP up to 60 days into the following calendar year. The final deadline for investing in your retirement savings plan is usually around March 1. Having this extra time in the new year will give you a chance to determine the optimal amount that should be contributed to maximize your tax deduction.
“Within the first 60 days, it is assumed that you have enough time and information available to determine your taxable income amount, the estimated tax you may need to pay and the RRSP contribution amount that would be required to offset that tax,” said Lamarche.
There are a few exceptions to that deadline:
- The year you turn 71, you can no longer contribute to an RRSP after December 31.
- If you are withdrawing from your RRSP through the Home Buyer’s Plan (HBP), that withdrawal must be used to buy or build a home before October 1 of the year following the withdrawal.
- If you are withdrawing from your RRSP through the Lifelong Learning Plan (LLP), you must register for a program of study before March 1 of the year following the withdrawal.
When to max out your RRSP or save ‘room’
Your RRSP can give you a tax deduction now, but when you make withdrawals, presumably in retirement, the full amount of the withdrawal is included in your taxable income. So, if you're expected to have a lower tax rate in retirement than you do now, it makes sense to maximize your RRSP contributions.
“You should also consider that the higher your tax rate is when you make a contribution, the greater you’ll benefit from that contribution,” advised Lamarche.
“Contributions to a Tax-Free Savings Account (TFSA) might make more sense if you are in a lower tax bracket.”
As long as you have RRSP room, meaning you haven’t contributed right up to your limit for that tax year, the value of your TFSA can be transferred to your RRSP at a later date.
“You can save for retirement using a TFSA and when you find yourself in a higher tax bracket, move that money into an RRSP and get a bigger bang for your buck. In the meantime, the assets in the TFSA are growing tax-free,” said Lamarche.
Take advantage of spousal RRSPs
A spousal RRSP is one of the ways married or common-law couples can split income in retirement. This is especially advantageous if one spouse makes more money than the other. If one spouse has a large sum in an RRSP, it will mean that spouse will have to pay more income tax when those funds are withdrawn. If each spouse has the same amount divided between their RRSPs, both spouses will be in a lower tax bracket and have to pay lower income taxes in the future.
“Even though a spousal RRSP is opened by your spouse or common-law partner, you are able to contribute to it and get the tax deduction on your income,” said Lamarche.
“This income splitting strategy can save your household a significant amount of taxes both before and during retirement.”
Pre-authorized contributions can help you grow your retirement savings
Good saving habits make building your retirement savings a lot easier. A Pre-Authorized Contribution (PAC) to your RRSP or TFSA can be a helpful tool in your savings plan.
A PAC is a recurring automatic withdrawal that transfers a pre-specified amount of money from your bank account and puts it into your RRSP or TFSA. You can schedule a PAC for the date you get your paycheque, or weekly, bi-weekly, semi-monthly or monthly. You choose the amount of money you want to deposit each payment period.
“A PAC makes it easy to allocate money to your savings. There are no regular updates to make and no risk of forgetting to make the transfer. They also provide the benefit of investing earlier so you can benefit sooner from the tax-deferred growth,” said Lamarche.
A PAC also allows you to take advantage of dollar cost averaging. This is when you buy a fixed dollar amount of a particular investment on a regular schedule, regardless of the share or unit price. You can purchase more shares when the prices are low, and buy fewer shares when the prices are high, averaging out the price of your total investment.
Don’t put all your eggs in one basket
“The most common known example of diversification is given in the saying, ‘don’t put all your eggs in one basket’. If you drop that basket you will break all of the eggs. By putting each egg in a different basket, you’ll increase the probability of maybe dropping a single basket, but there is significantly less risk of losing all your eggs,” advised Lamarche.
That is why it’s a good idea to diversify when investing. Putting all of your money in the stock of a single company is not a wise choice. Even if you’ve done the research and determined that the probability of that company failing is extremely low, if something unexpected happens you could lose everything.
Your financial advisor will show you how to diversify your RRSP portfolio so you are investing in multiple companies and in essence, putting your eggs in multiple baskets. If one of those companies should fail, you’ll have limited exposure and it will not destroy your entire retirement savings plan.
To learn more about maximizing your RRSP contribution, contact an ATB Financial Specialist in your area.