Now that it’s RRSP season, it’s time to dust off your finances and see if you can boost your retirement nest egg, and get a tax deduction as well. Here’s what you need to know about RRSPs.
RRSP: The Basics
If you have Earned Income, a Social Insurance Number and are 70 or under, it’s possible to contribute to an RRSP. RRSP season is the first 60 days of the year when it’s possible to make a contribution and apply the tax deduction to the previous year. You can still lower your previous year’s tax bill — and improve your retirement portfolio — as long as you are within that 60 day time threshold.
How much can you contribute?
The contribution for the year is the lower of 18% of your Earned Income from the previous year or the maximum annual contribution limit for the taxation year (less any company sponsored pension plan contributions). For income from 2014, the maximum contribution is $24,930.
One of the great things about the RRSP is that you have the ability to carry forward unused contribution room. For most taxpayers, the easiest way to find your RRSP limit is to look for your CRA Notice of Assessment. When your tax return is processed, Canada Revenue Agency sends this to you each year.
How the RRSP Can Benefit You
Not only do you receive a tax deduction for your contributions you also benefit by growing your wealth over time, making for a happier retirement. Over the long-term, tax deferred compounding really helps your RRSP grow faster. In your RRSP, you can hold any number of investments, including stocks, bonds, and various funds. If you consistently invest money, the magic of tax deferred compounding means your nest egg grows better over time, resulting in a larger portfolio in the end.
Defer the tax deduction
Another great feature of the RRSP is the fact that it’s possible for you to defer your tax deduction if you wish. If you know that you will be in a higher tax bracket next year, or the year after, you can make your contribution this year, pay tax as usual, and “save” the deduction for a time when your higher tax bracket means that you benefit more. And, in the meantime, your investment continues to grow taxdeferred.
Other uses of the RRSP
Finally, it’s possible to use your RRSP to achieve other financial goals. If you have been saving up to buy your first home, your RRSP can be used in your strategy. Say you’ve been saving up, and you have $25,000 to use as a down payment on a home. You also have $20,000 in unused RRSP contribution room. You can take part of that chunk of capital you have saved up and use it to fill up your contribution room. Now, you have a tax deduction. Because you can use money from your RRSP penalty to buy your first home, you can turn around and take that money out again for use in your down payment.
So, you have a tax benefit, just for knowing about this little trick. It’s also possible to use your RRSP to give yourself a student loan. You can borrow up to $20,000 to pay for qualifying education, but you have to pay it back over 10 years. Still, it’s better to borrow from yourself — and pay yourself back — than it is to pay interest to someone else.
Before RRSP season comes to a close, evaluate your situation and determine whether or not it makes sense for you to employ a new strategy. RRSPs may not be for everyone but it still remains the best tool for retirement savings because of its powerful tax benefits.
Jim Yih is a best-selling author, fee-only financial advisor, a professional speaker and the founder of the award winning blog www.RetireHappy.ca. You can find him on twitter @jimyih.