Did You Make Your RRSP Contribution?

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If you caught on to the theme of my last few posts, you probably could have guess that RRSP season was upon us. Every year less and less Canadians make a contribution to their RRSP. The invention of the TFSA has definitely changed the mindset of many who invest and some would even prefer to use that over the RRSP. The other factor is that debt levels in Canada remain high. People with large mortgages are finding it increasingly difficult to to find the extra money they need to contribute to their retirement savings. Even with all those factors, the RRSP still remains the most popular retirement tool for many Canadians.

The deadline to make a contribution for 2014 is tomorrow, March 2, 2015. Those reading this blog today will still have time to run out to the bank or call their financial broker to make a contribution on their behalf. It’s become somewhat of a ritual for many individuals to make a last minute dash to get their contributions in before the deadline. It’s almost like those people who prefer to do last minute Christmas shopping. Just be aware, that just like Christmas, the line ups and wait times could be significantly longer.

The Rules

  1. There is a maximum amount that one can contribute to their RRSP. It’s equal to 18% of your 2013 earned income or up to a maximum of $24 270. For some individuals the maximum can be higher depending if contribution room was carried forward from previous years. The easiest way to tell how much you can contribute is to review your tax return documents from last year. The contribution room for the following year is explicitly stated by the Canadian Revenue Agency.
  2. A tax of 1% per month will be applied if the contribution limit is exceeded. Needless to say, don’t go over your contribution room.
  3. Contributions made to an RRSP are eligible for a tax credit. The amount that gets returned will differ from each individual, but in general, it will be based on the marginal income tax rate that the individual falls under.
  4. As this blog has mentioned before, RRSP withdrawals are taxed at the marginal rate. This means that taxes are not actually saved, but deferred. The amount of taxes paid on withdrawals will depend on the financial situation of the individual making the withdrawal.

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What You Shouldn’t Do

  1. Don’t maximize your RRSP contributions if you are going to retire with a defined pension. Upon withdrawal, the money from your RRSP will get taxed at the marginal rate on top of what you will receive from the pension. This will most likely cause you to pay more in taxes. Use a TFSA instead if you fall into this category.
  2. Don’t spend the tax refund. So many people make the mistake of spending the money they receive back from the government. Remember that taxes still need to be paid back when the money is withdrawn. The money that you receive back is that tax amount. Unless you plan on living in the no tax income bracket when you retire, it’s not prudent to spend your refund. Reinvest it instead.
  3. Don’t put your money into a GIC, money market fund or a savings account. An RRSP account should be used to invest for the long term. A diversified and balanced portfolio similar to the ones on the Canadian Couch Potato site will outperform GICs or any guaranteed interest that the bank is offering. There are great tutorials on that site that will show you how to set up a portfolio.

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What You Should Do

  1. Contribute to a spousal or common-law account if that applies to you. There are so many benefits to using a joint RRSP over having an individual one when it comes to future taxation. The one caveat that still exists is that contributions made must still be claimed by the individual that made the contribution. This means you cannot claim the tax credit against the person with the higher income only.
  2. Open a brokerage account to invest your RRSP with. If you are comfortable with investing yourself, you can open a self-directed brokerage account and make trades yourself. Otherwise, an advisor can make the trades for you on your behalf. When using an advisor just be aware of some of the pitfalls.
  3. Hold back your claim on your tax credit if you don’t have to use it. It’s great getting money back right away, but there are some other advantages to holding back the claim. If you know you are going to get a raise next year and push yourself into a higher income bracket, you can use amounts contributed this year on the next year’s tax return. You can also use the tax credit in subsequent years where you make more earned income through other investments.

It’s Not Too Late

There’s still one day, so it’s not too late to make a run for it. If you’re still confused as to whether or not contributing is good for you, then comb through my archives and check out some of the other posts I’ve written about RRSPs. In general, saving anything for retirement is better than nothing.

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