Time is running out to max out your 2016 RRSP contribution. Amid the annual RRSP blitz from various financial institutions to invest before the March 1st deadline, we should remind ourselves that this should be a continuous process – not just a rite of February.
The RRSP has been around for 60 years, created by the federal government to help Canadians who are not members of an employer pension plans save for retirement. It allows you to fund your own “pension plan”, and like a pension plan, contributions are tax-deductible and grow tax-free. The resulting long-term tax deferral accelerates growth and should be a key element in your retirement planning.
As you contemplate topping up your RRSP contribution this year, here are ten tips and strategies you should know.
1. Contribute the maximum to your RRSP
Where possible, to make the most of the powerful long-term tax deferral, you should contribute the maximum amount to which you are entitled. Your limit is 18% of your previous year’s “earned income”, subject to an annual dollar limit, which for 2016 is $25,370 and for 2017, $26,010. For most people, earned income comprises employment income, business and/or professional income and net rental income, and a number of other income sources. If you are a member of an employer pension plan, don’t forget that your RRSP limit is further reduced by a pension adjustment, which is the deemed value of pension benefits earned during the previous year and can be found on your T4 slip.
2. Remember unused RRSP contributions are banked
If you are unable to contribute the maximum, remember that you can “bank” the resulting unused contribution room for future years. So in fact your maximum 2016 limit is equal to your 2016 contribution plus any unused contribution room from previous years. But be careful not to contribute beyond your contribution-room. Where you have an over contribution you are required to file Form T1OVP and pay a tax equal to 1%-per-month on any excess contribution over $2,000!
3. Contribute early to your RRSP and increase your savings
Your savings should be considerably greater if you contribute to your RRSP as early as possible in the year, allowing your savings to compound faster and making the most of the long-term tax deferral. Consider making your maximum 2017 contribution now, rather than at the March 1, 2018 deadline. Another early-contribution strategy is to enroll in a monthly investment plan, and in so doing request your employer to reduce income tax withheld at source.
4. Contribute now, deduct later
For a year in which your income is low, you will still be able to make a contribution based on the previous year’s earned income. In such a case, it might be to your advantage to make a contribution but delay claiming the related deduction to a future year when your marginal tax rate will be higher. This will let you immediately benefit from tax-deferred growth, but allow you to claim the deduction in a later year when you will be in a higher tax bracket, thus increasing the tax savings. Determining whether to claim the deduction or wait should be balanced against the immediate benefit of being able to invest the tax refund.
5. Use a Spousal RRSP to benefit from income splitting after retirement
Pay less tax during retirement by contributing to a spousal RRSP. The goal is to produce two relatively equal streams of income in retirement that will be taxed at a lower combined tax rate. With a spousal RRSP, the savings belong to your spouse, but you claim the deduction. Your total contributions to both your own and spouse’s plan are limited by your own contribution room. Separately, your spouse also can contribute up to his or her limit as well.
6. Know all available RRSP investment choices
As with any investment portfolio, you should build a portfolio that will maximize potential growth at your appropriate level of risk. Many types of investments are eligible for an RRSP, including cash instruments (typically GICs and treasury bills), mutual funds and segregated funds, investment-grade bonds and debentures, government-insured mortgages, publicly traded stock and options, certain small-business shares, and gold and silver bullion. For many years now, there has been no foreign-content restriction for RRSPs, which means theoretically an entire portfolio can be non-Canadian. And keep in mind the added benefit of holding U.S. Dividend Paying stocks within your RRSP. Unlike U.S. shares held within a non-registered account or TFSA, U.S. dividends paid are not subject to foreign withholding taxes because of the Canada/US tax treaty.
7. Contribute shares in kind to your RRSP
If you have RRSP-eligible investments in a non-registered account that you want to retain, you can also use them to make a contribution in kind. The transfer is done at the shares’ fair market value and may trigger a capital gain. Keep in mind that where the shares have decreased in value you cannot claim a capital loss when making a contribution in kind. However, you can still claim a loss by selling the shares on the market, contribute the proceeds in cash to your RRSP, and then repurchase the shares within your plan 30 days or more later (thus staying onside with the anti-avoidance rules).
8. Consider the pre-RRIF contribution to your RRSP
RRSPs must be converted to a RRIF or registered annuity before the end of the year you turn age 71. But before making the conversion, consider making a final RRSP contribution if you will have RRSP room available in the following year. This may be the situation where you are still working or have rental income, for example. While the contribution will result in an over contribution tax and requirement to file form T1OVP, assuming you had earned income in the year before you turned 71 – you’ll have the benefit of claiming a deduction in the following year when your contribution room will have increased.
9. Early RRSP withdrawals – in limited situations
Although, ideally you should leave your funds in your RRSP until retirement, you don’t have to wait till retirement to withdraw funds from an RRSP. It only makes fiscal sense to do so in a year in which you have significantly lower income, such as in-between jobs or to take an unpaid sabbatical, which would be taxed at a low rate and where you don’t have other funds available in either a non-registered account or TFSA. Be sure to weigh the advantage of making a low-tax withdrawal against the benefit of maintaining tax-deferred savings by leaving the money in the RRSP.
10. Make full use of RRSP rules
The RRSP is one component, albeit an important one, of your overall retirement plan. Taking advantage of the various rules and flexibility surrounding the RRSP can significantly increase your retirement nest egg. If in doubt, please seek professional advice.