Contributions to RRSP accounts made before February 28th can be considered for tax deductions to an individual’s personal income for the previous year. This deadline often conjures up thoughts on retirement planning along with investing in pension plans.
Before considering a defined benefit pension plan available via an individual pension plan for corporate shareholders – consider that a registered retirement savings plans can offer an immediate and potentially a long term tax break with low costs. To understand this, recall that Canada has a progressive tax rate – as you move to higher tax brackets, you pay a higher rate of tax. A contribution to your RRSP is an immediate deduction to your income – and the deduction starts at your highest tax bracket. Withdrawals from your RRSP are added back to your income in the year withdrawn – increasing your income in that year.
As such, consider where you are in your income earning years before making contributions or taking withdrawals from your RRSP. Planning for future years may consider taking income for 2018 up to $145,722 for the maximum $26,230 contribution (in 2017 up to $144,500 for the maximum $26,010 contribution.)
For example, an individual making $165,000 in Alberta would pay 42% tax on income over that amount (and below $205,031). A contribution of $14,000 to an RRSP would save that person about $5,880 in tax in the current year. That $14,000 is allowed to grow without incurring tax until funds are withdrawn. Say that $14,000 grows to $18,000 – When the individual still residing in Alberta withdraws that $18,000 in their retirement (and that is the only income they earn) – they would pay at most tax at the lower tax bracket of 15% (only for income over the basic exemption of $11,810) or $928. They save $4,952 overall and gain on the time value of money.
Also consider that in other investments you must pay tax on earnings each year. Investments within an RRSP grow on a tax deferred basis – allowing for faster growth. This is effectively a tax free loan from the government.
RRSPs also offer income splitting opportunities in retirement through spousal RRSPs. An individual can contribute to an RRSP in their spouse’s name. The account is owned and controlled by their spouse – however the individual uses their own deduction limits and received the deduction on their own taxable income. The goal would be to have level income in retirement for couples that may have large variances in taxable income throughout their careers. Note if the spouse makes withdrawals from the spousal contributions within three calendar years of the contribution date – the income will be added back to the original contributor’s income in the withdrawal year.
Misconceptions of RRSPs is that the money should only be taken out in retirement – this is not necessarily the case. RRSPs should be withdrawn when income is low or when the individual making the withdrawal is in a lower tax bracket. This is often in the years leading to retirement (especially where pensions are involved) or between jobs.
Consider in retirement that you may receive CPP and OAS as well as other pensionable earnings. In the year you turn 71 you must move your RRSP into a RRIF and start making withdrawals. If you are anticipating income from other sources after age 71 – you may want to move your RRSPs into a non-registered dividend earning investment to lower your overall after tax cash over a number of years. This type of planning is becoming more and more effective.
To attain the most tax effective RRSP – invest into the plan when your income is highest and make withdrawals when your income is at its lowest. This can be done by looking at overall income levels and making estimates over a period of time. Your contribution limits are carried forward to future years.
Effective investments for tax purposes within your RRSP would include certain foreign dividend type of income – as treaties such as the tax treaty between Canada and the US have no withholding tax deducted from those dividends for RRSPs and RRIFs or other retirement income.
RRSP planning should be considered in conjunction with other retirements plans such as the defined benefit pension plans and individual pension plan. If would be advantageous to have your financial advisor talk to your accountant for both contributions and retirement planning to gain a tax and financial planning perspective.
This information is for discussion purposes only and should not be considered professional advice. There is no guarantee or warrant of information on this site and it should be noted that rules and laws change regularly. You should consult a professional before considering implementing or taking any action based on information on this site. Call our team for a consultation before taking any action.