RRSPs should be part of your retirement planning

By Admin Wednesday February 12 2014 in Business
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+ (RRSPs) help you save for retirement in the future, while giving you a tax break today. In the tips below, expert Chartered Professional Accountants discuss Registered Retirement Savings Plan (RRSP) basics to help you get started on retirement planning.


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Why is an RRSP a good idea?

 

“An RRSP helps you save for retirement while providing an immediate tax benefit when you make an RRSP contribution,” says Bruce Barran, CPA, CA, a partner with Davis Martindale LLP in London. “Ideally, you make RRSP contributions when you are in a higher tax bracket and withdrawals when you are in a lower one.” RRSPs also accumulate compound investment income on a tax-deferred basis. “Government pensions are not enough to retire on,” Barran adds. “You need to plan ahead for retirement and RRSPs are a good retirement savings vehicle.”


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How do I start an RRSP?

 

“You can set up an RRSP through a registered financial institution such as a bank, through an investment broker or through a financial planner,” says Barran. “Your RRSP can include many kinds of investments, such as GICs, stocks, bonds, and mutual funds.”

 

When setting up an RRSP, you can rely on an advisor to choose and manage your investments, or take a more active role by setting up a self-directed RRSP.


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Should I put my money in an RRSP or a TFSA?

 

RRSPs provide tax deductions for amounts contributed (up to a certain limit) and allow earnings on your assets in the RRSP to accumulate tax-free. As well, the funds in your RRSP are only taxed when withdrawn, which can create significant savings if you withdraw the funds when your income and marginal tax rate are lower, such as after retirement.

 

You can contribute $5,000 per year since 2009 ($5,500 for 2013 and 2014, or, cumulatively $31,000 to date) to a Tax Free Savings Account (TFSA). TFSAs are more flexible than RRSPs because you can take money out without affecting your ability to use a TFSA again in future years. Contributions to TFSAs don’t give you a tax deduction, but when you withdraw money from them the accumulated contributions and income you receive are not taxable.

 

So which one should you put your money into?

 

“That really depends on what your marginal income tax rate is now, and what you expect it will be in retirement,” says Claudio Saverino, CPA, CA, a senior tax manager with BDO Canada LLP in Markham. “If you are in a high tax bracket now, and expect tobe in a lower one later, RRSP contributions effectively move income that would be taxed at a higher rate now into a lower tax bracket later. This produces both a tax deferral and a tax saving.”

 

If you are in a lower tax bracket now, and expect to be in the same lower tax bracket later in retirement, a TFSA might make more sense than an RRSP. “This is because using an RRSP could put you into a higher tax bracket in retirement, while the deduction arising from the contribution now will be at the lowest marginal rate,” explains Saverino. “Also, having lower income in retirement may allow you to keep more of your government benefits that are income tested, such as Old Age Security.”

 

If you have funds now, but may need to use them before retirement, contributing to a TFSA temporarily may be wise. “Contributing to an RRSP and withdrawing the funds soon after is not usually a good idea,” says Saverino. “Although the income and deduction may offset each other, if the contribution and withdrawal are in the same year, this still eliminates RRSP contribution room. In this situation, a better plan could be to put the money into a TFSA and then later withdraw and contribute the funds to an RRSP once you are sure you won’t need the money until retirement.”


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How much money should I put in my RRSP?

 

“You can contribute as much money as you want to your RRSP,” says Saverino. “However, there are limits on how much of your contributions are tax deductible and there is a penalty tax for contributions over these limits.”

 

While it is advisable to maximize your RRSP contributions, in order to accumulate sufficient funds for retirement you should generally limit your contributions to the amount that is currently tax-deductible.

 

“If you contribute more than your limit, you will be subject to a one per cent per month penalty tax to the extent that the over-contribution amount exceeds $2,000,” says Saverino. “This penalty tax is expensive, so it is not worthwhile to contribute above your limit.”

 

Generally, the limit for a year is 18 per cent of your previous year’s earned income, up to a maximum amount of $23,820 in 2013 and $24,270 for 2014. This amount is reduced by the previous year’s pension adjustment and Pooled Registered Pension Plan contributions and increased by any carry-forward contribution room.


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Should I borrow to put money in my RRSP?

 

“Generally speaking, I would advise against borrowing to make an RRSP contribution, unless the loan is temporary,” says Jean-Paul Lafrance, CPA, CA, a tax partner with BDO Canada LLP in Ottawa. “The interest you pay on a loan is not tax-deductible and the RRSP will be generating interest that will eventually be taxable. Unless the loan interest rate is very low, or you can repay the loan within the year, then don’t borrow to make an RRSP contribution.”


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Should I put money in my RRSP or pay down my debt?

 

Deciding between an RRSP contribution and paying down your debt depends on many factors, especially the interest rate on your debt. “If the debt is a high-interest rate loan, like a credit card, pay it down first,” advises Lafrance. However, if your debt is a low-interest loan, like a car loan or a mortgage, it may make sense to put money into your RRSP. Just be sure to use any tax refund from the RRSP contribution to pay down your debt.”


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When should I start saving for retirement?

 

“The earlier you start saving for retirement, the earlier your money can start compounding and the longer you’ll have it working for you,” says Gregory Clarke, CPA, CA, Partner with SB Partners LLP in Burlington. “Contributions to an RRSP result in a tax deduction, which is a key benefit that people obtain with RRSPs. In addition, income earned within the RRSP is tax-free, but it is taxed when you withdraw it at a later date.”

 

To start an RRSP, you must have a social insurance number and earned income. The amount of your previous year’s employment income is used to determine your contribution room for the next tax year. For 2013, each taxpayer’s annual contribution room is calculated as 18 per cent of their 2012 earned income, to a maximum of $23,820, less any required pension adjustments. Also, any unused contribution room from previous years is carried forward, so the amount that you can contribute may be higher.

 

“The best reason to start an RRSP early is that it gets young people into the habit of saving,” explains Clarke. “Even if it’s a couple hundred dollars a year, it helps create a mindset that saving is important.”

 

To make an RRSP contribution to get a deduction on your 2013 personal tax return, you will need to make your contribution by March 3, 2014.


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The cost of withdrawing money from your RRSP

 

If you withdraw money from your RRSP, here’s how it will affect you financially.

 

“If the withdrawal is $5,000 or less, you’ll be subject to tax of 10 per cent withheld at source; 20 per cent if the withdrawal is greater than $5,000 and less than or equal to $15,000; and 30 per cent for amounts greater than $15,000,” says Henry Korenblum, CPA, CA, a manager in the tax group at Crowe Soberman LLP in Toronto.

 

Korenblum suggests that you consider several smaller withdrawals rather than one large lump-sum payment to reduce the tax withheld at the time of the withdrawal. “The reduction is only a tax deferral, as the withdrawn amounts must be reported on your tax return where they will be subject to your regular tax rate,” he explains.

 

Keep in mind that in situations where a taxpayer makes a single request to withdraw an amount in instalments, the withholding tax would be based on the total amount to be withdrawn.


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What is my RRSP deduction limit?

 

“Your RRSP deduction limit is the cumulative amount you can contribute to an RRSP during the current year based on the Notice of Assessment from Canada Revenue Agency (CRA) for the prior year,” says Ted Cossitt, CPA, CA, of Grimsby. “The Government of Canada has determined that an appropriate amount to be set aside for a taxpayer’s retirement years is 18 per cent of one’s earned income. This 18 per cent includes contributions to one’s RRSP as well as employee and employer contributions to a registered pension plan, but is in addition to the Canada Pension Plan contributions.” Your deduction limit is also available on the CRA website at www.cra-arc.gc.ca.

 

In addition to the 18 per cent limit, there is an annual dollar amount limit that caps the addition to the deduction limit. This amount is indexed every year and stands at $23,820 for the year 2013 and $24,270 for the year 2014.

 

“Most computer tax programs will calculate your RRSP deduction limit as part of the tax return preparation,” says Cossitt. “It is important that the balance carried forward into the year is entered correctly so that this calculation is accurate.” The CRA also calculates this balance annually and reports the amount on the annual Notice of Assessment.

 

“The Notice of Assessment will also note any RRSP contributions that have been made but not yet deducted on the individual’s tax return,” adds Cossitt. “You are permitted to have undeducted contributions in excess of your deduction limit by up to $2,000. If they are in excess of $2,000, penalties will be incurred. If the $2,000 over-contribution is never deducted from income, it will still be taxed when drawn out.”


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Is there a minimum RRSP contribution limit?

 

“There is no minimum RRSP contribution from an income tax point of view,” says Cossitt. “However, many financial institutions will probably have a minimum amount that they require to open or keep open an RRSP account.”


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How much do I need in my RRSP to retire?

 

“How much money you need to have in your RRSP depends on the answers to many questions,” says London’s Bruce Barran. “For example, do you have a company pension or other investments outside your RRSP? How much do you need to live on? Some people can live comfortably on $30,000 a year and others can’t live comfortably on $100,000.”

 

While there is no magic number for the size of your RRSP, consider your savings goal in the context of your overall retirement plan. “If you have a pension or other investments, you may not need to rely as much on an RRSP,” explains Barran. “How much you will need to retire also depends on your desired lifestyle and when you decide to retire.”


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What fees are associated with RRSPs?

 

“There are fees for some types of RRSPs and none for others,” says Barran. “If you walk into a bank and open an RRSP with a GIC, there is no fee. However, if you opt for a Self-directed RRSP, or some other types of investments or packages there can be a fee.”

 

Before choosing your RRSP, determine what, if any, fees are charged to set it up and to manage any transactions, such as buying or selling stocks. “Fees are costs that erode your investment return,” says Barran. “It is good to keep costs down if you can.”


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How long can I pay into my RRSP?

 

“At the end of the year in which you reach age 71, your RRSP will mature and the funds in your plan must be removed,” says Markham’s Saverino. “If you still have unused RRSP contribution room, or will continue to generate earned income, you can make RRSP contributions to a spousal RRSP after the year in which you turn 71. However, your spouse must be under age 72 for this to be possible; otherwise, his or her RRSP will have matured as well.”

 

When your RRSP matures, it must be collapsed. “Any amounts withdrawn will be fully taxable to you in the year of withdrawal,” explains Saverino. “Your RRSP issuer will withhold tax on your withdrawal. The withholding tax rate varies with the size of the withdrawal.”

 

You can also purchase an annuity or Registered Retirement Income Fund (RRIF) with your matured RRSP funds. “Generally you would do this when you want to receive retirement income in the future from your old RRSP funds,” says Saverino. “Withdrawals from an annuity or RRIF would be taxable only when received by you.”


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Who should use spousal RRSPs?

 

If you have available RRSP contribution room, you can contribute to an RRSP for your spouse. For 2001 and subsequent taxation years, a spouse includes a same-sex partner.

 

“Your contribution to a spousal RRSP will qualify as a tax deduction for you as long as your total contributions to your plan and the spousal plan do not exceed your contribution limit for the year,” says Saverino. “The main benefit of the spousal RRSP is that it allows income-splitting in the future, at retirement, since withdrawals will usually be taxable in the hands of your spouse.”

 

When deciding whether to contribute to your own or to a spousal RRSP, try to estimate both your and your spouse’s income from all sources in retirement. “Your goal should be to equalize these incomes at that time,” explains Saverino. “By doing so, you will achieve income-splitting, which will help to minimize your taxes in your retirement years.”

 

Pension income-splitting rules permit splitting eligible pension income with your spouse. “This may result in a reduction in the total tax payable by your spouse and you,” says Saverino. “However, if both spouses have an RRSP in retirement, you will have more flexibility when splitting income.”


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When should I take money out of my RRSP?

 

“As its name says, an RRSP is for retirement, so the money inside it should not be taken out until then,” says Ottawa’s Lafrance. However, there are some exceptions. “If you are buying your first home, you can take out up to $25,000 for the down payment,” says Lafrance. “You might also want to take money out of your RRSP in a year in which your income is very low.”

 

If you are going back to school for full-time studies, you can borrow $10,000 a year for two years from your RRSP. “However, you usually must pay it back within 10 years, according to prescribed rules,” says Lafrance.


Brought to you by the Chartered Professional Accountants of Ontario

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