Every year, right around this time, the government and our banks remind us that taxes are creeping up - along with the reminder for RRSP investments. While it’s easy to tune out the noise, it’s advice we might want to consider. Here’s why:
RRSPs Are Your Biggest Tax Break
Every penny you contribute to your RRSPs is tax deductible. That means, if necessary, you can effectively bump yourself in a lower tax bracket by making the right contribution. For example, if you’re in the top tax bracket, for every $1,000 you contribute, you save $400 in RRSP tax savings.
Each Tax Year, Your Contribution Limits Increase
As your tax preparer or small business accountant will tell you, your RRSP contribution limit is scheduled to increase each year. According to this article from the Toronto Star,“For the 2010 tax year, you can contribute 18 per cent of your 2009 earned income, to a maximum of $22,000, less any pension adjustment (the benefit you received from an employer’s pension plan or deferred profit sharing plan in the previous year).” For 2011, your contribution limit will increase to $22,450, and will then be indexed to inflation based on wage increases for the following years.
Whatever Room You Don’t Use Gets Carried Forward
Don't have the maximum amount on hand this year? Perhaps the best part about RRSPs s is that if you do not contribute the maximum allowable amount, the unused room is carried forward for another year, so you never miss out on your possible savings.
RRSP Growth is Not Taxable Income
Every dollar that you contribute to your RRSP account is allowed to grow tax-free. While withdrawals are taxable, like the Home Buyers' Plan, which pulls up to $25,000 out for a downpayment and repaid in installments. However, as long as the money is left in the account, it will continue to grow – tax-free.
Even If You Have a Pension, RRSPs are Important
Even if you’re lucky enough to have a job that offers a pension plan, don’t be under the impression that this will be enough on its own. Often, the plans offered aren’t enough to carry you through retirement entirely. For this reason, you should take advantage of an RRSP as well.
How to Take Advantage of Your RRSPs
1. Time your contributions right. Interestingly, you don’t have to use the tax deduction your RRSP contribution offers immediately. The advantage of this is that you can use them in a year when your salary increases significantly, putting you into a higher tax bracket.
2. Don’t touch your savings. It’s tempting, I know. There’s a lot of money growing in that account and you could certainly use it for something more “fun” than savings. But know that every dollar you remove from your RRSPs is subjected to taxes at the time of withdrawal. Not only that, but you permanently lose your original contribution room, meaning that you are not allowed to contribute the amount you’ve withdrawn.
3. Take advantage of automatic deductions. When it comes to tax time, most of us just don’t have the maximum contribution limit on hand to invest. For that reason, you might want to consider taking advantage of automatic contributions, which allow you to small contributions throughout the year when you have more money on hand.
4. Choose the right investment for you. It’s true; most banks will only offer you their in-house products, such as mutual funds and GICs. But if you have more money in your account – say, $25,000 or more – you should consider moving that money to a self-directed RRSP, which can be found through various brokerages and financial institutions. The main difference between a self-directed RRSP and a tradition option is the opportunity to pursue savings options from other banks, meaning you can choose from just about any type of investment, which means more flexibility to make choices that are right for you.
If you haven’t done so yet, make an appointment to talk to your financial advisor about contributing to your RRSPs this year.