If you haven’t made your RRSP contributions yet, you need to make some key decisions today that could result in major tax-savings tomorrow. Contributing to an RRSP is one of the best ways to reduce your taxes and plan for your retirement.
The benefits of making regular contributions to your RRSP pay off in both the short and long term. Besides reducing your taxes on the current year’s return, you will also build tax free investment income over the lifetime of your RRSP investments.
When you withdraw money from an RRSP for your current needs or your retirement income, that money will be taxable at that time as ordinary income (as opposed to capital gains income). For this reason, it is sometimes better to hold investments that are expected to generate significant capital gains outside of an RRSP due to the lower tax rate afforded to capital gains income.
But the tax deductions and tax-free accumulations you gained by making the contribution in the first place will likely save you more than if you had saved the same amount without putting it in an RRSP. In most cases, you should be able to contribute up to 18% of your earned income for the previous year into an RRSP, although you are limited to legislated maximum contributions.
Here are some key tips to help you get the most from your RRSP contributions:
- Contribute more when you make more. You can save tax by contributing to an RRSP when your income is high and taking money out when your income is lower. If you lost your job or were unable to work, you could withdraw money from your RRSP, which you had contributed in years you had higher earnings, equal to the value of your total personal tax credits without paying any tax. Note that taxes are withheld on RRSP withdrawals at rates that depend on the amount withdrawn. In the above situation, however, these taxes would be fully refundable upon filing your personal tax return.
- Top-up your spouse’s RRSP. This is a simple form of income-splitting between spouses. If your household has only one income-earner, or if one person earns substantially more that the other, the higher income-earner can pay into their spouse’s RRSP up to their own yearly contribution limit. This is a win-win for everyone; the higher income earner saves taxes, while the lower one does not have to pay taxes on the contributions until they are withdrawn at a later date.
- Consider borrowing to max out your RRSP contributions. Your RRSP investments could earn you more than the cost of borrowing and you will still enjoy tax deferred growth in future years. While the interest on an RRSP loan cannot be deducted from your income, the contributions you make will reduce your overall income, resulting in a tax savings. You can then use your tax refund to pay down your loan. If you have unused RRSP room from previous years, you may want to borrow to top-up these contributions as well.
Each year you have until March to squeeze in your RRSP contributions and still benefit from the deduction of the contribution from your income for the current tax filing year. However, you should develop an RRSP strategy at the beginning of the new tax year, not the end. Setting up automatic deposits with your bank is one of the easiest ways to do this.
A dollar today is worth much more than a dollar tomorrow, so the sooner you can start contributing to your RRSP, the more time your money has to earn interest and grow.
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