A Registered Retirement Savings Plan is one of the best ways to save for life after work (RRSP). Contributions to an RRSP are tax-deductible, and the income you earn from investments in your RRSP is not taxed until you carry it out. This lets your savings grow even faster.
Contributions to your RRSP
The Government restrict how much you can put into an RRSP. The most you can put into an RRSP is 18 percent of your income from the year before, minus any pension adjustments, up to a maximum amount for the tax year. In 2020, the most you can spend was $27,230. You can give money at any time this year or in the first 60 days of the next year. Visit My Account or MyCRA on the Canada Revenue Agency website at any time to find out how much you can contribute.
Accounts for RRSPs Offer Multiple Advantages
Tax savings
You can protect on taxes by investing money into an RRSP up to the RRSP deduction limit for the year. You can also “catch up” in future years if you don’t use all of your contribution room.
Tax-delayed growth
You can use stocks, bonds, options, mutual funds, exchange-traded funds (ETFs), savings deposits, treasury bills, and guaranteed investment certificates (GICs) to build and manage your RRSP (GICs). You don’t have to be a taxpayer on the growth of your investments until you start taking money out of them. You’re assumably in a lower tax bracket and paying less in taxes by this time.
Income splitting
You can use a spousal RRSP if you think your spouse’s retirement income will be less than yours. By putting part of your annual contribution into a spousal RRSP, you can build a separate retirement fund for your spouse and get a tax break. Each year, you can split your allowed contributions between your RRSP and a separate spousal RRSP you set up for your spouse. You get the same tax break as if you had only put money into one RRSP.
Types of accounting and taxation
In Canada, different taxes are put on different kinds of income. Because perks and capital gains are taxed at a lower rate than wages and interest, dividing your investments between your taxable and registered accounts can affect how much you owe in taxes.
In a non-registered account, interest income, eligible dividends, and capital gains are taxed in different ways, as shown in the table below. The highest minor tax bracket for an Ontario resident in 2020 is used in these calculations.
Special Circumstances Withdrawal Plans
If you take money out of your RRSP, it will be considered income and taxed at your marginal rate. There are, however, two-position in which you can temporarily take money out of your account without paying interest:
Mortgage loans
The Home Buyers’ Plan (HBP) lets you take up to $35,000 ($70,000 for a couple) from your RRSP to buy or build your first home. You can pay back the money you took out over time. If you or your spouse haven’t owned and mostly lived in a home in the last four years, you are considered a first-time home buyer. You have 15 years to pay back the money you took out of your RRSP most of the time.
Back-to-school borrowing
Under the Lifelong Learning Plan, you can also use your RRSP to pay for your education or the education of your spouse or common-law partner (LLP). You can take out up to $10,000 in a calendar year and up to $20,000 from your RRSPs.
Planning Your Retirement
Define your objectives.
First, you need to figure out what retirement means to you. Do you want to go somewhere? Are you thinking about getting a smaller house? Will you keep living the same way, or will a lot change?
As a general proposition, you can expect to need 70% to 80% of your annual income before retirement to keep living the way you do now. But the amount you need will mostly depend on what you want to do when you retire. Your age, health, amount of debt, and family obligations will also change how much money you need.
Plan your way
If you know what you require to do when you retire, you can get a good idea of its cost. The further step is to figure out how much money you have.
Make a balance sheet to start.
To figure out your net worth, list everything you own (your assets) and subtract what you owe (your liabilities). If the number isn’t as high as you’d like, try one or more of the following to boost your nest egg:
Make the most of your RRSP
You can “catch up” on your contributions if you have unused RRSP contribution room from previous years. Your RRSP may still have a lot of tax-deferred growth, which means that your investments can continue to grow.
Diversify your RRSP by putting both stocks and bonds in it. This will reduce volatility and increase your potential returns. Be sure also to take advantage of different ways to split your income, such as spousal RRSPs. This will help make your retirement income the same as your spouse’s, lowering your overall tax bill.
Eliminate debt.
You have less money to spend when you retire because you have to pay off debt. If you have several smaller debts with high rates, like credit card balances, you might want to consider getting a line of credit to pay off all of your debts at once. With the low rates and flexible terms available today, a line of credit can allow you to pay off high-interest debt.
Organize your investments.
Consolidating your assets with a single financial institution may simplify the management and diversification of your portfolio and minimize the expenses associated with investment management.
Optimize the tax efficiency of your portfolio.
Do you pay the government more than you should? There are different ways to tax different kinds of income. Interest income, for example, is taxed at the full rate, while capital gains and dividends from Canada are taxed less when they are held outside of a registered plan. You can make sure that you pay as little tax as possible on your registered and non-registered investments.
