Reducing your taxable income by contributing to your RRSP will mean a lower tax bill or a higher tax refund. In addition to lowering the tax you’ll owe on your income in the year you make your contributions, any earnings you make on your RRSP investment will be tax deferred—you’ll only start to pay income tax on them in the year you start making withdrawals from your retirement fund.
You can calculate the estimated tax savings of your RRSP contributions. First, determine the tax rate that applies to your income level. Then multiply your total RRSP contribution by that tax rate and you will have an approximate calculation of the amount you’ll avoid paying in taxes (or receive as a possible refund).
2. Should I max out my RRSP contributions?
There is an annual limit, set by the government, on how much you can contribute to your RRSP. It makes sense to maximize your RRSP contributions if you’re expecting to have a lower tax rate in retirement than you do now. This is because an RRSP offers a tax deduction now, but when you make withdrawals (presumably in retirement), the full amount of the withdrawal is included in your taxable income.
“You should also consider that the higher your tax rate is when you make a contribution, the greater you’ll benefit from that contribution,” advises Lamarche. “Contributions to a Tax-Free Savings Account (TFSA) might make more sense if you are in a lower tax bracket.”
While you do have to pay income tax on contributions to TFSAs, the interest earned through a TFSA is (as the name suggests) tax-free, meaning you’ll never have to pay income tax on it.
The value of your TFSA can be transferred to your RRSP at a later date, provided you have the RRSP contribution room to accommodate the transfer.
“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,” notes Lamarche.
3. What are the advantages of spousal RRSPs?
One of the most common and effective methods of income splitting between spouses or common-law partners is with the use of a spousal or common-law partner RRSP. Income splitting refers to transferring income from the higher-income spouse to the lower-income spouse, resulting in lower total tax.
An individual RRSP is opened for a person who intends to save for their own retirement and claims a tax deduction against their own income. In contrast, a spousal or common-law partner RRSP provides for retirement savings for one spouse or common-law partner with the income deduction being claimed by the other. The purpose of this strategy is to provide both individuals with similar incomes and similar tax rates in retirement.
“Even though a spousal RRSP is opened by your spouse or common-law partner, you contribute to it and get the tax deduction on your income,” says Lamarche. “This income splitting strategy can save your household a significant amount of taxes both before and during retirement.”
4. How do I simplify saving by using pre-authorized contributions?
Good habits can 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 strategy. A PAC is a recurring automatic withdrawal that transfers a pre-specified amount of money from your bank account to your RRSP or TFSA at a regular interval (say, biweekly or once a month).
“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,” explains 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.
5. Is it important for my RRSP investments to be diversified?
“The most commonly 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,” says Lamarche.
Putting all of your money in the stock of a single company—or even a single sector or geographical location—is not a wise choice, even if you’ve done your research and believe that the risk of your investments depreciating 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, sectors and locations (in essence, putting your eggs in multiple baskets). If one aspect of the market should fail, you’ll have limited exposure and your entire retirement savings plan will not be destroyed.
RRSP contribution deadline for the tax year
The Government of Canada will allow you to contribute to your RRSP up to 60 days into the following calendar year. For example, the final deadline for investing in your retirement savings plan for 2022 is March 1, 2023. Having this extra time in the new year gives you a chance to determine the optimal amount you can contribute to maximize your tax deduction. (There is an exception to this rule in the year you turn 71. You can no longer contribute to your RRSP after December 31 of that year.)
To learn more about planning for your retirement, and how to maximize your RRSP contributions this year, reach out to one of our experts at 1-855-541-4387.
For more information about how your tax bill will be affected when you start withdrawing from your RRSP or convert your RRSP to an RRIF, check out more retirement savings FAQs here.
