Ready. Set. Go! The sprint to make RRSP contributions before the deadline has begun. This makes it a great time to look at RRSPs, how they work, best practices, and how much is too much.
A Quick Summary of RRSP Taxation
Let’s begin by refreshing ourselves with the main features of the RRSP. RRSPs are registered accounts, meaning they are registered with the Canadian government to receive certain tax benefits.
RRSPs have two tax benefits. One, contributions are tax-deductible – effectively reducing your taxable income. Two, all growth made in an RRSP is tax-sheltered. However, when it’s time to pull money out of your RRSPs, the taxman will come knocking – withdrawals must be reported as income and taxed at your personal income tax level.
Best Practices in Building Your RRSP
- Start ASAP. RRSP season may be a sprint but saving for retirement is a marathon – open an RRSP early. The sooner you add money the longer it can grow. Allowing your money to make you more money.
- Add regularly.Setup regular contributions to your RRSP (monthly, bi-weekly, etc.) – a ‘set it and forget it’ approach is best. This saves you from that mad rush to add at the beginning of the year and allows for dollar-cost averaging. Dollar-cost averaging can reduce the overall impact of price volatility and lower the average cost per share/unit when investing.
- Top up during RRSP season! Run a quick tax calculation in January/February and add to your RRSP, before the deadline, if it is beneficial.
- Create a retirement plan. Plan – preferably with your wealth advisor – to ensure to are on the right track towards retirement and not headed off course.
How Much is Too Much?
There are specific scenarios in which contributing to an RRSP can be too much of a good thing. Those include:
1. You’ve overcontributed to your RRSP.
If you add more than your contribution limit, you will eventually receive a letter from the Canadian government informing you of your penalty ... which may be significant. Check your last Notice of Assessment, myCRA portal or ask your accountant for your current contribution limit.
2. You’ll trigger OAS Clawback.
If your RRSP and pension savings require you to make large withdrawals in retirement, your OAS benefits may be reduced (known as OAS clawback). Map out your retirement income with your advisor to see if this applies to you.
3. All your income sources in retirement are taxable.
CPP, OAS and pension withdrawals are taxed as income just like RRSPs. If all your sources of retirement income are taxable, it could create future financial stress. Especially when large extra expenses arise such as trips, vehicles or medical expenses. Ensure you have savings in accounts that provide tax-free withdrawals (such as TFSAs or non-registered accounts) for better tax planning in retirement.
To get the most out of your RRSPs contact KLT Wealth Management.
- Courtney Beach, QAFP
