With two weeks left until the 2011 RRSP contribution deadline on February 29, 2012 it seemed like a good time to blog about some common client questions I receive on the subject, “Why should I contribute to an RRSP?”, “What are the benefits of contributing to my RRSP?” or, “Should I borrow money to contribute to my RRSP?” While everyone’s situation is different I just wanted to summarize the rules of RRSP’s so individuals can make informed decisions when deciding whether to or how much to contribute.
The main benefit of contributing to an RRSP is the tax deferral. There are two significant tax deferrals available through RRSP’s:
Any withdrawals are then brought into income and are thus taxable in the year that they are withdrawn from the RRSP. It is most tax advantageous to withdraw in years with lower income (resulting in lower tax rates), most commonly your retirement.
The RRSP annual contribution limit is equal to 18% of your earned income for the preceding year up to an annual limit of ($22,450 for 2011 and $22,970 for 2012). It is the most tax advantageous to contribute in years that you have a high income, thus you are reducing your income at higher marginal tax brackets. Some individuals will even determine what their income will be for the year and then contribute an amount to lower themselves to the next marginal tax bracket.
There are some restrictions as to what the funds in ones RRSP may be invested in. Investments must be “Qualified Investments” as defined by the income tax act. Some common “Qualified Investments” include but are not limited to GIC’s, shares in public corporations, mutual funds, deposits in a credit union, mortgages, and certain secured debt . You should contact your Chartered Accountant if you have any questions whether an investment qualifies. If an RRSP is invested in something that is not considered qualified, then usually the Canadian Revenue Agency (CRA) will deem it a withdrawal, the amount is then considered income in the year and it is no longer in the RRSP.
There is no correct answer that applies to everyone regarding how much and when to contribute or how much and when to withdraw, several factors such as age, debt levels, available cash, other pensions, ownership of private corporations are significant factors to consider.
There are other issues related to RRSP’s that I will be blogging on in the future such as Home Buyers Plan, Registered Education Savings Plan (RESP), Tax Free Savings Account (TFSA), and Registered Retirement Income Fund (RRIF). Let me know if you are curious about these topics in the meantime.
Disclaimer: The information in the blog is for general information only and is not intended to be a substitute for professional advice. Each person’s situation is unique, and a designated professional accountant can assist you in using the information on this blog to your best advantage. The author of this blog strives, but does not guarantee, to provide information which is current and accurate. Due to the nature of the information, it should not be relied upon for decision making without talking to a designated professional accountant. By obtaining information from this blog, you fully release Steve Watts, Chartered Accountant of any liability that may arise from using this information.