RRSPs:
10 things you need to know
Pity the poor Registered Retirement Savings Plan (RRSP). With middle age setting in after more than 50 years – and the new tax-free savings account getting all of the attention – the lowly RRSP can seem like yesterday’s news.
In fact, nothing could be further from the truth. RRSPs continue to represent one of the most significant tax savings opportunities available to individual Canadians – and one of the most effective ways of saving for retirement.
Here are 10 things about RRSPs that highlight the central role they can play in your financial planning for retirement, along with some tips on how you can maximize the benefits they provide.
1. Your biggest tax break
The taxes you save with RRSP contributions are significant because every contribution you make is tax deductible. If you’re in the top tax bracket, every $1,000 you contribute gives you over $400 back as a tax break.
2. RRSPs grow tax free
That $1,000 also grows tax-free inside your RRSP account. This tax-sheltering accelerates the growth of over the years and provides a huge boost to your retirement nest egg. While all withdrawals are taxable, you will have enjoyed many years of tax-sheltered growth in the meantime, and – if you keep your RRSP intact until retirement – you may also benefit by being in a lower tax bracket when you start making these withdrawals.
3. Time your contributions
The tax deduction for your RRSP contribution can be carried forward indefinitely, so you can make use of it in a future year when it would be more advantageous. For example, if you have an income of $60,000 this year, but expect that salary increases and promotions might bump your income to $90,000 in a few years time, holding off on claiming your deduction could increase your tax savings by as much as 50 per cent due to the fact that you’ll be taxed in a higher tax bracket.
4. RRSPs matter – even if you have a pension
Other than top-end public sector pensions, few plans are designed to provide all of the retirement income you’ll need, so saving on your own through an RRSP can be essential. For example, let’s assume your workplace pension plan provides 40 per cent of your needed retirement income of $45,000, with government programs such as the Canada/Quebec Pension Plan and Old Age Security providing 30 per cent. That still leaves you to come up with the remaining 30 per cent. That’s where saving through your RRSP can be so important.
5. Contribution limits increase
Your RRSP contribution limit is scheduled to increase each year, so if you’re able to make the maximum contribution, you’ll want to keep track of contribution limit changes.
For the 2012 tax year, you can contribute 18 per cent of your 2011 earned income, to a maximum of $22,970, less any pension adjustment (the benefit you received from an employer’s pension plan or deferred profit sharing plan in the previous year). The contribution limit will increase to $23,820 in 2013, and then be indexed to inflation based on increases in the average industrial wage for years following.
6. Unused room can be carried forward
If you don’t use up your contribution limit in any one year, your unused contribution room is carried forward indefinitely. So you can always catch up on your contributions if you don’t save the maximum amount in any given year. That said, the sooner you get your money in your RRSP, the more time your investments will have to compound, or earn interest on the interest. That extra time can mean a big boost to your retirement savings.
7. Don’t dip in along the way
It’s so tempting to withdraw money from your RRSP to handle some of life’s little needs or challenges, or to take advantage of the Home Buyers’ Plan for a home purchase or the Lifelong Learning Plan to pay for education expenses.
But those early withdrawals can be costly. For example, if you withdraw $10,000 from your $100,000 RRSP nest egg – and your remaining RRSP assets earn a 6 per cent return each year for the next 20 years – your RRSP will be worth more than $56,000 less than if you hadn’t made the withdrawal.
In addition, when you withdraw funds from an RRSP (other than through the Home Buyers’ Plan or Lifelong Learning Plan), you permanently lose the contribution room that you originally used to make your deposit. While you can continue making your maximum contribution to your RRSP in the future, you are not allowed to re-contribute the amount you withdrew.
8. There’s plenty of choice
If you went to your local bank branch several years ago to open your RRSP, chances are that your investment choices have been limited to their own “in house” mutual fund and GIC offerings. If you have a growing account balance ($25,000 or more), you should consider moving your savings to a self-directed RRSP. A self-directed RRSP is available from many financial institutions (such as full service and discount brokerages) and is no different than other RRSPs, only your investment choices are not restricted to in-house brands. This means you can choose from virtually any qualifying investment, from individual securities like stocks and bonds, to exchange traded funds, to GICs and mutual funds from any issuer or fund company. More choice means more flexibility in making the investment choices that are right for you.
9. Allocate investments tax effectively
If you are saving through both an RRSP and a non-registered account, consider structuring your portfolio to hold investments that are taxed at a higher rate, such as GICs and bonds, inside your RRSP and hold investments that are taxed at a lower rate – those that generate dividends and capital gains – inside your non-registered portfolio. This strategy allows you to maintain your desired asset mix of investments while minimizing the taxes you pay on your non-tax-sheltered investment income.