Monday, January 18, 2021
Your Guide to RRSP Season: 2021
As we enter the last half of January, we start to put a bow on the previous year and focus on the present. One of the items we wrap up is the previous year’s taxes and corresponding RRSP contribution. The 2021 deadline for RRSP contributions is March 1st and before that day comes, I want you to be ready. Many people I meet have no clue how an RRSP works or even why they have it. The confusion surrounding this product is vast and as your favorite Financial Advisor, I will give you the facts. We have 6 weeks till the deadline, and it is time we finally understood Canada’s favorite retirement vehicle.
Created in 1957 as a way for self-employed persons to save for their retirement. The Registered Retirement Savings Plan, known as the RRSP, grew huge popularity over the decades to become Canada’s preferred method of saving by the late 1980s. If you follow me, you will understand my bucket analogy when referring to Investment Vehicles. Like the Tax-Free Savings Account, known as the TFSA, the RRSP also has tax advantages associated with it. They are both essentially buckets that hold your investments, sheltering them from tax. Let’s dive deeper.
Any contribution made to your RRSP is made with “pre-tax” dollars, meaning the money you have NOT paid tax on yet. What this does is lower the amount of income you made that year, thus lowering how much money you pay in tax. Any growth within the RRSP account is also “tax-deferred.” What this means is that gains made annually within your RRSP account do not trigger a taxable burden that year. Tax is simply paid when you withdraw your money, ideally at retirement, and the amount of tax you pay when you withdraw is based on your marginal tax rate at the time. The main premise is that you save tax now, and then pay it later when you are retired and are hopefully at a lower tax rate.
I mentioned how growth within the RRSP is tax-deferred. How would you go about making your money within the RRSP grow? The answer is simple, invest it. RRSPs can hold a variety of investments including cash, bonds, Guaranteed Investment Certificates (GICs), Mutual Funds, Exchange-Traded Funds, Index Funds, Stocks, and a few other types of investments. For the most part, it will be your goal to have your RRSP invested in something that will grow over time and fully utilize the tax-sheltering within the account.
Your RRSP contribution limit is based on your income. You can put a maximum of 18% of your annual income into an RRSP, and that number is capped. The maximum annual contribution for 2019 was $26,500 and it changes upward every year slightly, to adjust for inflation. Unused RRSP contributions carry forward, meaning if you do not put the full amount into your RRSP, you can make up for it in a future year.
As mentioned, any withdrawal from an RRSP is taxed at your marginal tax rate at the time you take the money out. For instance, if you take out $5,000 from your RRSP and that year you made $50,000 in income, the government will tax you for $55,000 of income, meaning you will owe some money for the $5,000 you took out. The makes it very disadvantageous to take money out early from your RRSP. Your RRSP can be open until the age of 71 at the latest. At that time, you will have to start withdrawing from your account. The Registered Retirement Income Fund, or RRIF as it’s known, is what your RRSP will morph into at age 71. You will be taxed at your marginal tax rate at that time for any withdrawal.
RRSP Home Buyer’s Plan
The Canadian government’s Home Buyers’ Plan (HBP) allows first time home buyers to borrow up to $35,000 from their RRSP for a down payment, tax-free. If you’re purchasing with someone who is also a first-time homebuyer, you can both access $35,000 from your RRSP for a combined total of $70,000. However, since the HBP is considered a loan, it must be repaid within 15 years.
Life-Long Learning Plan
The Lifelong Learning Plan (LLP) is a government program that lets you temporarily withdraw money from your Registered Retirement Savings Plan to pay for full-time education or training. You can withdraw up to $10,000 per year up to a total of $20,000, but it must be repaid within 10 years. The money can be used by you, your spouse, or your common-law partner. It cannot be used for your children’s educations.
Your workplace may offer an RRSP known as a Group RRSP. Often, they will put in a percentage of your income to encourage you to save for your retirement. This is known as a company match. This is a key recruiting tool for many employers. You can also set up an RRSP for your spouse called a Spousal RRSP. This allows a higher-earning spouse to help top up their spouse’s account and still receive the taxable benefits of the RRSP.
I have mentioned the benefits of opening an RRSP already, but let’s get down to the nitty-gritty. Here are some examples of how an RRSP can save you money on your taxes.
Annual Income: $60,000
Annual Taxes Owed: $14,156
% of income saved in an RRSP – % in real dollars – Tax money saved as a result
5% of your income – $3,000 saved total – $890 saved in tax
10% of your income – $6,000 saved total – $1,779 saved in tax
18% of your income – $10,800 saved total – $3,202 saved in tax
As you can see, simply by putting money into your RRSP, you pay less tax on the year. That is less money you have to give the government and more money in your pocket for your future. We also mentioned the “tax-deferred” growth you can get from simply investing in an RRSP. While it may not seem like a lot of savings at first, compound interest and time can really make your savings add up.
Amount Saved Annually: Total after 10 years – 20 Years – 30 Years (8% interest annually)
$3,000: $44,083.64 – $141,933.47 – $359,124.89
$6,000: $88,167.29 – $283,866.95 – $718,249.79
$10,800: $158,701.12 – $510,960.51 – $1,292,849.61
These are some incredible numbers and what they translate into as income for you during retirement is pretty incredible as well.
Amount Saved in RRSP: After-tax annual income in retirement per year over 30 years (4% interest annually)
$359,124.89: $20,768.19 annual income from RRSP
$718,249.79: $41,536.42 annual income from RRSP
$1,292,849.61: $74,765.59 annual income from RRSP
Like anything in life, the more you put in, the more you will get out. You can see how those retirement savings add up if you utilize your account to the fullest. You can also see how having a company matching program and government benefits such as the Canada Pension Plan (CPP) and Old Age Security (OAS) will springboard your income in retirement. The key is to stay consistent and put as much in as you can every year. You are essentially building your own pension during your working years.
The Big Picture
There is a reason the RRSP is still the favorite savings vehicle for Canadians trying to build a retirement nest egg. In my opinion, the main reasons for this are simple. Most people when they contribute to their RRSP, consider that money gone, or not to be used. This gives the ultimate sense of “set it and forget it” as these savings do penalize you with tax by taking them out early. Getting that money in the form of a tax-return every spring is very nice as well. My recommendation would be to take those tax savings and re-invest them into your RRSP once you receive them. Even better is watching your money grow over time and compound interest really kick into overdrive.
TFSA versus RRSP
This question comes up quite often in my world. The Tax-Free Savings Account (TFSA) came on the scene in 2009 as another vehicle for Canadians to save and invest their money. If you follow me, you know that I think EVERYONE needs a TFSA. It is extremely valuable as a long-term savings tool, especially if you are younger and have many years until retirement. While the answer is different for everyone, you are never wrong by starting with a TFSA and working your way towards the RRSP. The 2 accounts can work together. As mentioned, your RRSP contribution room carries forward, so you never need to worry about not putting money in. Also as mentioned, once you put money into your RRSP, it becomes disadvantageous to take it out, so if you may need that money in the near term, you are better off dumping it into your TFSA first. This is where the help of a trained professional can help. They can guide you as to which account is better suited to your needs.
Always take the match
I cannot stress this enough. If you do nothing else for your retirement savings in your life, utilizing your companies matching program is a MUST. Free money from your employer is exactly that, FREE. You will not find an investment ever that doubles your money guaranteed every year. This must be utilized and your livelihood in retirement may depend on it.
The RRSP was put in place to incentivize Canadians to save for their futures. As the Defined-Benefit Pension Plan (full-ride pension) fades away, personal savings have taken the fore-front. Furthermore, the flexibility with managing your own savings may even put you ahead of the game. We can choose how we invest our money rather than some panel of pencil pushers struggling to get yield. While many will complain about the backend taxation of the RRSP, we must remember that this is money we never paid tax on, to begin with. I personally would rather know what I am up against and then have control over my money and how it is invested. The key is to invest early and often. Most importantly, you must invest efficiently with a “long-term growth” mindset.
Joseph James Francis is a Financial Advisor and Money Coach based in London, Ontario, Canada.
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