It's RRSP season again!
It's a great time for advisors to meet with their clients so that they can maximize their contributions before the deadline on March 3, 2014. For those who are unfamiliar with the term, RRSPs are Registered Retirement Savings Plans, they let you set aside money for retirement and allow the money to grow tax-free until it's withdrawn. You can hold a variety of investments in your RRSP like stocks, bonds, GICs (Guaranteed Investment Certificates) and Mutual Funds. Recently, a Sun Life Financial/Ipsos Reid survey found that only 36 per cent of Canadians are contributing to an RRSP, so it's important to map out the advantages and parameters to RRSPs and contributions.
Some of the advantages to contributing include, the tax deduction received when contributing, the fact that there are no taxes on your growth and that any contributions up to your annual limit reduce your taxable income for that year. In regards to withdrawals, they may only be re-deposited if you have sufficient additional contribution room. Withdrawing later life, usually in retirement, will usually mean that you pay less tax as your income will be lower in retirement.
A couple of things to remember:
• For 2013, you're allowed to contribute the lesser of $23,820 or 18 per cent of your earned income for the previous year.
• If you have made contributions in January and February this year, you have the choice to either deduct this amount from your 2013 taxable income, or hold off on making the deduction.
• You don't have to deduct RRSP contributions from your taxable income in the year that you make them. Any amount you choose to not deduct can be carried forward indefinitely to a future tax return.
• You may want to consider holding off on deducting the full amount of your RRSPs if you expect to have a higher taxable income in later years.
One of the most frequently asked questions from my clients is, "Will an RRSP be effective for my retirement plan?" RRSPs are indeed effective. Your contributions reduce your annual income tax. And, assuming you'll be in a lower tax bracket when you draw the money out, you'll save substantially on the overall amount of tax you pay. They are usually not a good option for short-term savings, however, as money withdrawn from an RRSP will increase your annual income and may result in your having to pay more tax.
We are also asked about leveraging, which is also known as borrowing to make an RRSP contribution. In today's low-interest environment, an RRSP loan can work well, provided you pay it off quickly. The beauty of an RRSP loan is that if it reduces your tax bill and results in a refund from the Canada Revenue Agency, you can then use those funds to partially or entirely repay the debt. In working with an advisor they should be able to asses if this strategy will works for you by looking at your ability to repay the loan.
For some individuals a better solution is to make monthly contributions. This will ensure a portion of your pay is immediately contributed to your RRSP, allowing you to take advantage of dollar cost averaging which is purchasing the investment at regular intervals throughout the year, instead of purchasing once a year when the cost of the investment may be high.
So, you have contributed to your RRSP and are ready to retire, now what? Many people move their funds into a Registered Retirement Income Fund (RRIF). It's one of the ways you can turn your RRSP into an income stream to fund your retirement. A RRIF allows you to invest your money in many ways, from GICs to mutual funds, so it keeps growing and working for you. Meaning your savings will continue to grow every year tax free.
Each year you are required to take out a portion of your savings from your RRIF, which is subject to tax, but there's no limit on how much you can withdraw. In addition you can name your spouse as a beneficiary, so RRIF assets can be transferred to your spouses' RRIF or RRSP on your death. You can't keep your savings in an RRSP forever. It is important to note that at age 71, you can no longer keep your savings in an RRSP.
The March 3 deadline is rapidly approaching, now that you have read a little bit more about what an RRSP is and how they work, don't forget to contribute!
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