It's tax time!! The time of the year, when the phrase RRSP's start to buzz about in conversation. Things like 'I need to top-up my RRSP's' or 'RRSP Contribution Deadlines' are heard in the media and in general conversation too.
But do your really know what RRSP's are and what they do for you?
RRSP or Registered Retirement Savings Plan is a retirement savings vehicle for Canadian Residents. The best way to visualize the impact of an RRSP contribution is to use a real world example outlining the taxation implications now and during retirement.
Let's say that you're currently 30 years old, and looking to contribute to your RRSP this year. Your gross (or total income before deductions) is $100,000.
To get a really rough sense of taxes owing on this income level, I utilize the Ernst & Young Personal Tax Calculator. After inputting $100,000 into the calculator, the resulting taxes payable would be $23,648, resulting in $76,352 leftover (also known as the net income). This information is based on the 2017 taxation rates.
However, if a contribution is made to an RRSP ahead of the RRSP contribution deadline, the taxable income will change, thereby reducing the taxes owing.
For the sake of this example, let's assume $10,000 is deposited into an RRSP.
The math is this simple - $100,000 (is the original gross income) less the RRSP contribution of $10,000 results in new taxable income of $90,000.
So now, I input $90,000 into the tax calculator, and rather than $23,648 payable to the tax-man, only $19,920 in taxes are payable.
In other words, setting aside $10,000 into an RRSP, saves $3,728 in taxes ($19,920 payable at an income of $90,000 rather than $23,648 payable at an income of $100,000).
Now, here's the catch.
Eventually, the RRSP savings will be withdrawn (most likely in retirement years), so let's walk through an example of what happens at that point.
Imagine you're 65 and looking to use you're saved RRSP money. Now, you want to withdraw the $10,000 you contributed when you were 30. Upon withdrawal, the $10,000 is now seen as income, and is taxable based on your current earnings.
So imagine you have an annual pension of $40,000 and have now withdrawn $10,000 of your RRSP savings. Your taxable income is now $50,000 ($40,000 pension PLUS $10,000 RRSP money). Using the tax calculator, you punch in $50,000 and find that $8,285 is payable. Of course, for this example I'm using 2017 tax rates, when in reality, this would be based on the tax rates in effect at the time you withdraw.
The hope is that the RRSP money is sheltered from high tax rates in your higher earning years, and tax at a lesser rate when withdrawn in retirement years.
So inevitably RRSP money will be taxed - it's just deferring the tax and shifting the potential taxation amount.
Below are other common questions about RRSPs.
How much can I contribute in a given year?
After filing your tax return each year, your RRSP contribution limit is set for the current year. This is calculated by using:
- 18% of your earned income from the previous year, or
- The maximum contribution for the current tax year ($25,370 for 2016)
You can usually find your contribution limits on your annual tax filing, or by visiting the CRA website. You might find it handy to set up an online account with CRA so you can check tax payments and RRSP contribution limits whenever you feel the need. http://www.cra-arc.gc.ca/esrvc-srvce/tx/ndvdls/myccnt/menu-eng.html
Is RRSP money always taxable when it's withdrawn?
No, in two cases there are no tax implications when the money is withdrawn - this occurs when using the saved RRSP funds for education purposes and/or when purchasing a home. Of course, there are strict rules in both cases. Here are some of the highlights:
1. When using RRSP for Educational Purposes
This program is known as LLP or Lifelong Learning Plan. You can withdraw funds to finance full time educational training at a qualifying institution for a qualifying program. You can withdraw up to $10,000 each calendar year, and a total of $20,000. The best part is, you can re-use this program again and again, providing you bring your LLP balance back to zero before you participate again. You're given 10 years to repay the borrowed funds.
2. When Using RRSP for Purchasing aHome
Known as The Home Buyers' Plan, this program allows a first time home buyer to withdraw up to $25,000 in one calendar year. There are a million disclaimers about what type of home qualifies and what it means to be a first time home buyer. The catch…you have 15 years to repay the borrowed amount.
Is there an age at which you'll be forced to withdraw?
Yes, on December 31st of your 71st year, your RRSP account must be terminated. There are a number of options for termination. The most common might be to convert the RRSP into a RRIF (or Registered Retirement Income Fund). This ensures that an annual minimum withdrawal occurs as required by law. The minimum withdrawal amount is calculated using your age and the total value of the asset.
Can RRSP money be invested?
Yes. Rather than leaving RRSP funds in cash, most people choose to select an investment vehicle. There are a number of investment options. Some of these options include:
- Savings Bonds
- Income Trusts
- RRSP Eligible Mutual Funds
If my RRSP Money earns Interest While Invested, is the Earned Interest Taxable?
Not exactly. Any profits made in the form of interest, dividends, or capital gains are not taxed while held within the RRSP. However, once withdrawn, they would face taxation.
For more detailed information on RRSP's, you might find Investopedia helpful: http://www.investopedia.com/university/rrsp/rrsp1.asp