The RRSP is a unique type of investment account for Canadians that allows you to invest and grow your money tax-free until withdrawal. Furthermore, it’s tax-deductible, making it highly lucrative as your income tax for the year will be calculated after the deduction you’ve made for your RRSP contributions, but only if you make those contributions before your RRSP deadline.
The RRSP is pretty flexible and allows you to invest until a maximum limit. You’ll either be able to contribute up to 18% of your previous year’s salary, or a limit set by the government (you’ll go with whichever is lower). If you fail to max out your yearly contribution, the leftover amount will simply slide over to the next year, allowing you to reap its benefits. RRSP accounts are matured when you turn 71 years of age, after which you can no longer contribute to it. You do have to pay taxes while withdrawing from the fund. However, RRSPs are mostly beneficial for people who’re at the peak of their earning curve, as that lets them take full advantage of the RRSP taxation rules.
Many Canadians start to worry about their RRSP deadline during the first two months of every year, because missing it could mean a missed chance to save on taxes for the year prior. In this article, we’ll cover all you need to know about RRSPs and whether you need to worry or not about your RRSP deadline.
What Exactly Is An RRSP?
RRSPs are a type of retirement account. RRSP stands for Registered Retirement Savings Plan, and The idea is to keep adding money to it until the age of 71. Its best advantage is that you don’t have to pay any taxes on the money inside it, unlike with most other savings accounts. There is another advantage, however, mainly that contributions made to an RRSP are tax-deductible.
What does this mean?
Well, if you take money from your yearly income and transfer it to your RRSP account, you could be pushed into a lower-paying bracket of income after that deduction, and in short pay less in taxes.
Suppose the government taxes you at 26% on a salary of $100,000. Now, imagine you put some of your salary into an RRSP account before filing your taxes. After transferring some of this money into your RRSP investment or savings, you’ll be taxed on the money you have left. That means lower taxes on a seemingly lower income amount. Here’s a table showing how your money would be affected if you chose to work with an RRSP vs. if you chose to play alone.
|Income||RRSP Deposit||Income Left After RRSP Deposit||Income Tax Rate||Total Money Left (RRSP Deposit + Income Left After Tax Cut)|
|$100,000||$0||$100,000||26%||$0 (RRSP) + $74,000 (Income After Tax) = $74,000|
|$100,000||$18,000||$82,000||20.5%||$18,000 (RRSP) + $65,190 (Income After Tax) = $83,190|
As you can see, you’re left with a considerable amount of extra money if you invest in an RRSP account.
When’s The RRSP Deadline?
This year’s RRSP deadline is March 2, 2020, keep that date in mind and don’t let it slip away, because it could potentially save you thousands of dollars this year. You need to contribute to your RRSP account before then in order to keep your money growing tax-free. Otherwise, you’ll have to face a higher amount of taxes this year.
Related: If you’re looking for more ways to earn passive income, check out our ultimate list of 40 Ways To Earn Passive Income In Canada.
Should You Have An RRSP Account?
The truth is that RRSP accounts aren’t for everyone. They’re mostly for people who are in their working prime and in their prime earning years. If you’re in your mid-30s or 40s, an RRSP makes the most sense for you. That’s not to say that younger people who still haven’t reached their peak income level shouldn’t or cannot use this type of account. However, there are other options that might suit them more (like TFSA’s), but we’ll get into that in another article.
If you think you may benefit from this, an RRSP makes perfect sense and is a great move as it’ll really let your money grow exponentially as years go by. Millions of Canadians take advantage of RRSPs to grow their wealth tax-free, and for good reason. Adding to your RRSP account reduces your income tax for the year.
Related: Looking to invest safely? Check out the best robo advisors to get started.
What’s The Catch?
Well, there’s a limit to the amount of money you can add each year.
Of course, if you could just dump all your earnings into an RRSP it wouldn’t be sustainable for the government, that would mean not having to pay taxes on any of your income. That’s why RRSPs have a yearly limit that you have to abide by, and this limit changes each year. To give you an idea, here are the contribution limits for the last few years.
However, that’s not the only thing you have to take into account when considering how much you can invest in your RRSP this year.
If 18% of the salary from your previous year is below the upper limit ($27,230) provided by the Canadian government, you’ll invest 18% of your salary instead.
However, if 18% of your salary from last year is higher than the government provided upper-limit ($27,230), then you can invest an amount equal to the upper limit instead.
Here’s a table that’ll help you understand this concept:
|Salary||18% Of Salary||RRSP Limit||RRSP Deposit For The Year|
What Happens If You Miss The RRSP Deadline
In short, you’ll pay more taxes and lose out on money that you could’ve saved up instead. That’s not all, however. There are a couple of things you should keep in mind if you’re in a situation where you’re about to miss your RRSP deadline.
1. You Don’t Have to Max Out Your RRSP Contributions For The Year
If you can max out your contributions, that’s great! But if not it’s alright too.
You can contribute as much as you want to your account for the year. That means as little as you’d like – the only problems with contributions arise when you’re maxing them out. Even if the deadline is drawing near, there’s no need to fret about it. Just add as much as you can to your account. If that helps you to lower your income tax for the year, great! In any case, it’s simply more money in your RRSP account that’ll keep growing tax-free until you retire.
2. If You Don’t Max Out Your Yearly Contribution, The Left-Over Will Move Onto Next Year
That’s another great thing about the RRSPs. Even if you can’t contribute as much as you would have liked, or missed the RRSP deadline entirely, you’ll just be able to make up for it the next year. Sure, you might pay more taxes this year, but that’s the extent of it. But if you have the money to do so, you’ll still be able to contribute everything you missed out on during the next year.
For example, if your limit for this year is $10,000, and the limit for your next year is also $10,000, and you only contributed $5,000 this year, you’ll be able to contribute $15,000 next year. It’s simple enough and makes it convenient for you to keep contributing to your RRSP account on the regular.
One of the best things that you can do for your RRSP account is to keep contributing in small amounts every so often. An ideal scenario would be to contribute every month, or at least somewhat regularly so you don’t run into any issues down the line. It can be quite stressful if the deadline is on the horizon and you don’t have the money to contribute. The money you save on your taxes due to your RRSP can also be invested into it the next year, which makes the account and your contributions to it all the more valuable. That’s why it’s a great idea to contribute when you can. You’ll be saving hundreds of thousands for your retirement without even noticing.
You Pay Taxes When Withdrawing From Your RRSP Account
Getting your investments and savings secure before the RRSP deadline might mean that you won’t have to save taxes for now. But, you’ll still have to pay taxes on that money based on your income level when withdrawing your funds.
That might sound like a downside, but it isn’t. No taxes whatsoever might be a dream for some, but just getting taxes for withdrawals is the next best thing. While getting your money out of your RRSP account, you’ll be taxed at your income tax level at the time. There’s a good chance that you won’t be making much as you’re about to retire or have retired completely, which would make your RRSP your sole source of income. You know what that means! A lower income means a lower tax bracket, which means you’ll have saved up tons of money in the long run.
There are many ways that you can take advantage of your RRSP savings. You can also use your savings earlier than your retirement for studies. Opening an RRSP account with a spouse has additional benefits if you play your cards right. Supposing you’re the higher-earning partner, you can deposit through your spouse account (which is called a spousal RRSP) to potentially pay less in taxes on account of both being in a lower tax bracket. On the other hand, the spouse who earns less can be the one to withdraw the funds, allowing both partners to pay less on taxes during the withdrawal phase. Of course, this is all regulated by Canadian law to avoid people taking advantage of these programs for tax elevation, but if you’re a regular, law-abiding citizen, it’s a great way to enter retirement.
Related: If you want to invest in a low-risk manner, Nest Wealth can help you out. Alternatively, you could invest in RRSP GICs.
In Summary: Contribute Before The RRSP Deadline Whenever You Can
Whether it’s a small amount or a large one, you should contribute to your RRSP account on the regular. It’s one of the surest ways to have a comfortable retirement ahead.
Even if you have other investment and savings accounts, it’s smart to max out your RRSP first, since it’ll lower your income tax for the year, which really makes a difference in your overall outlook. You can invest your remaining money (perhaps the very money that you saved on taxes) for your other investment accounts.
Missing the deadline isn’t too much of an issue. You can simply contribute the following year, but you’ll be at a disadvantage. That’s because you’ll have to pay more taxes than you otherwise would have, had you maxed out your RRSP contributions.
All in all, RRSPs are a great investment and retirement savings vehicle. If you live in Canada you should definitely be taking advantage of what they offer.