The ABC’s of RRSP’s
The Financialist • Issue 100 • January 2009
BY JACQUELINE SIAH BSc CFP CIM CLU
As we enter the New Year, another RRSP season fast approaches. But if past years are any indication, only about a quarter of eligible Canadians will be making any RRSP contribution at all. Given that the RRSP is often described as the best government-created program to assist citizens in preparing for retirement, it is somewhat surprising that more Canadians don’t take advantage of this great savings tool.
In simple terms, an RRSP is a savings/investment vehicle that allows for tax-deferred growth until funds are withdrawn. Withdrawals from an RRSP are permitted at any time, but the withdrawal amount is included as taxable income. Theoretically, you will be in a lower tax bracket when you start withdrawing funds from an RRSP or RRIF. As such, the funds will be withdrawn at a lower tax rate than when they were contributed.
When you make a contribution to your RRSP, you get a tax deduction for the amount contributed. The deduction reduces taxable income, so the higher your marginal tax rate, the greater the tax savings will be. If, for example, your marginal tax rate is 42%, a $10,000 RRSP contribution will save you about $4,200 in taxes for the year. The deadline for a contribution to be eligible as a deduction on your 2008 tax return is midnight on March 2, 2009.
The RRSP deduction limit is the maximum amount of RRSP contributions that can be claimed on a tax return for a given tax year. The deduction limit is generally calculated as 18% of earned income from the previous tax year, plus any unused contribution room carried forward, minus any pension adjustment (calculated by your employer if you are a member of a pension plan), up to a specified dollar maximum ($20,000 for 2008). You should refer to your latest Notice of Assessment to determine the maximum amount you can contribute to your RRSP. Overcontributions in excess of $2,000 are subject to a penalty tax of 1% per month until the funds are withdrawn.
Don’t have the cash for a contribution? You can arrange an in-kind contribution. If you hold securities outside your RRSP, you can transfer them directly into your RRSP and receive a tax deduction equal to the current market value. Note that capital gains in respect of transferred property are taxable, but capital losses are disallowed. In the latter case, it is advisable to sell the security first and contribute the funds in cash.
One of the easiest ways to contribute to an RRSP is to pay yourself first - this means making contributions periodically. Not only will you avoid having to come up with a large lump sum at once, periodic savings also allow you to dollar cost average – buying more when prices are low, less when prices are high. For more information on RRSPs and to tailor a plan that works best for you, please contact your Financial Advisory team.