You are about to become the target of the annual February ritual – the battle for your Registered Retirement Savings Plans (RRSP) contributions. RRSP contributions are the most widely known and consistently beneficial way to defer your current income taxes until retirement, when you will qualify for the additional exemptions that come with age.
Surprisingly, many Canadian taxpayers do not take advantage of this investment vehicle, which pays immediate returns and secures a long-term retirement plan.
What have you done for me lately?
While saving for retirement is a fantastic idea, a surprisingly large percentage of Canadians have little or no retirement savings, and no plan in place to build such savings. Excuses are all over the lot – no extra savings capacity, no time, no motivation. However, what many people don’t know is that current tax legislation can assist you in funding your RRSP. Let’s look at the current effects of contributing to your RRSP.
For example, take a single taxpayer who earns $50,000 annually through employment. The total tax savings on a $10,000 RRSP contribution for this taxpayer is $3,197. Therefore, after taxes, your net cash outlay is only $6,803. The $10,000 contribution (plus accruing investment income) is taxed when it is withdrawn from the RRSP account, ideally on retirement, when you are most likely being taxed at a lower rate and are taking advantage of income-splitting opportunities and other age-related tax benefits.
More savings opportunity with TFSAs
Effective January 2, 2011, Canadian residents are also able to contribute an additional $5,000 to their Tax Free Savings Account (TFSA) in addition to regular RRSP contributions.
TFSAs follow similar investment and contribution rules as RRSPs, with one very noticeable difference. Contributions to a TFSA are not deductible on your personal tax return, but income earned inside a TFSA over the years will remain tax-free, forever! And withdrawals are tax-free.
This gives you two methods to build wealth, save for retirement, and to do it tax efficiently at the same time.
Overcontributions to your TFSA or RRSP account are subject to a special tax by Canada Revenue Agency. Care must always be taken to insure you do not over-contribute.
A tax professional can review your tax situation, before investing, to give you an idea of your contribution limits and both the immediate and long-term benefits of an RRSP contribution.
Alan Rowell, DFA is founder of The Accounting Place, and specializes in working with individuals and small- to medium-size businesses to provide customized accounting and taxation services. He is recognized as one of the leading tax services specialists in Canada, and is a tax resource for a number of financial planners. He is also a frequent guest speaker has written widely on tax planning. Alan is a Strategic Educational Partner, Faculty Member, and Instructor with the Knowledge Bureau.
Generic Mutual Fund Disclaimer
Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the simplified prospectus before investing. Mutual funds are not guaranteed and are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that the fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently and past performance may not be repeated.
Personal Opinions & Recommendations Disclaimer
The foregoing is for general information purposes only and is the opinion of the writer. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. However, please call the author to discuss your particular circumstances.