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RRSPs: Your Essential Questions Answered

Feb. 24, 2021
7 mins
A woman sips her coffee as a man points to a document

At this time of year, it seems like the financial world is awash with information on what is a Registered Retirement Savings Plan (RRSP), the benefits of having one, and how to start one. But there are still a few planning points that Canadians either aren’t aware of or don’t know how to use to their full potential.

Essential RRSP questions:

How much should I contribute to my RRSP this year?

There’s no magic number.

Most people aim to contribute enough to maintain a similar lifestyle to what they enjoy when they retire. Although there’s considerable debate about the exact percentage, most experts suggest you’ll need 50% to 70% of your current income while in retirement.

The maximum you can contribute to your RRSP each year is 18% of your income up to a specific limit (the ceiling for 2020 is $27,230). If you’re managing anything close to that, you’re in great shape. Realistically though, contributing 10% to 12% of your pre-tax income each year is a reasonable target.

If you are carrying high-interest debt, you may be better off paying down that balance before contributing to your RRSP.

RRSP annual deduction limit

Year RRSP dollar limit
2021 $27,830
2020 $27,230
2019 $26,500
2018 $26,230

*Data from the Canada Revenue Agency (CRA).

For 2021, the deduction limit is $27,830 or 18% of your pre-tax income from the previous year, whichever is less.

Will I lose my RRSP contribution room if I don’t make a deposit?

No, if you have RRSP contribution room this year but can’t use it all, you can carry it forward indefinitely. On your Notice of Assessment, the CRA will calculate this year’s contribution room, plus any unused amounts carried forward from previous years, to show you the total amount you can contribute in the current year.

In the meantime, the only catch is that you can fall behind when it comes to potential growth. Remember, the early years of contributing to an RRSP make the difference. Compound interest can ensure you earn more from your initial investment.

Do I have to deduct my RRSP contribution on this year’s tax return?

No, and in some cases, you probably shouldn’t. Don’t confuse your RRSP contribution with your RRSP deduction.

But why wait? Most people anticipate their income, and therefore their tax bracket, increasing in the future. When you file your tax return, your RRSP contribution is deducted from your taxable income.

But if you don’t have enough income to deduct the entire amount effectively, you can carry it forward and deduct it in a subsequent year when you expect to earn more income and sit in a higher income tax bracket.

In simple terms, if the amount you deduct doesn’t allow you to drop into a lower tax bracket, it may be more worthwhile to postpone the deduction for a later date.

Why does it seem like I have so little RRSP contribution room?

Either you simply didn’t make a lot of income this year, or you’re in an excellent pension plan, possibly offered through your employer. Chances are, it’s the latter. If so, take a look at your Pension Adjustment (PA) — a number that reflects the value of the pension benefits you’ve built up in the company plan.

Your employer is required to calculate your PA and report it to the CRA for your T4 each year. The CRA then takes 18% of your earned income for the year (up to the maximum limit) and reduces it by your PA to determine your RRSP contribution limit for the following year.

Thus, a PA will reduce your annual RRSP contribution limit since you’re already earning some retirement benefits at work.

If I don’t make much income, does an RRSP contribution still make sense?

If you earn little income, an RRSP should be a low priority, mainly because there are no tax savings. Many low-income Canadians will gain less than they think from making RRSP contributions, particularly as they get older.

For instance, those who expect to receive the federal Guaranteed Income Supplement (GIS) when they retire should probably think twice about RRSPs.

GIS is currently available to Canadians earning less than $18,240 per year and couples with combined incomes under $24,096 (if your spouse/common-law partner receives the full Old Age Security pension).

However, extra income from RRSPs counts against GIS, as it adds to your total income. The amount you receive from GIS would be reduced by 50 cents for every dollar of retirement income above the threshold.

If your income is less than $18,240 and you can put a little bit away for retirement, investing in a tax-free savings account (TFSA) may be a better alternative to save in this scenario. Drawing on your TFSA won’t count against your GIS when you withdraw.

Should I borrow to maximize my RRSP contribution?

It depends. The actual math is complicated, but when you factor in projected rates of return, the tax breaks, and the cost of starting late, some people might be better off borrowing or taking out a loan to contribute.

If you don’t have enough cash on hand to jump in before the deadline, many financial institutions will structure a special RRSP loan. This loan usually has no payments for the first couple of months to allow you to get your tax refund before you have to start making payments.

Unlike interest on money borrowed to invest, interest on money borrowed for RRSP purposes isn’t deductible. But contributing will generate a tax refund, which in turn could be used to pay down the amount you borrowed.

To figure out if this route is really for you, you should first estimate the rate of return on your RRSP. If it is higher than your loan interest rate, and you can comfortably handle the payments, then borrowing money to use toward RRSP contributions can pay off.

One rule to follow: your loan interest rate should be at least 2% below your expected RRSP return, and your loan term should be no more than five years.

What if my spouse (or separated spouse) withdraws money from our spousal RRSP?

If one of you made little-to-no income this year, making a withdrawal may make sense. When you make less income, you are in a lower tax bracket, and your withdrawal subsequently won’t be taxed as much. You may even want to invest that money outside the RRSP.

Withdrawals from a spousal RRSP plan have to be declared as income by the spouse or partner who is the plan holder. However, if your spouse withdraws the funds within three calendar years of your contribution, you’ll have to declare the amounts withdrawn by your spouse and pay tax on them as well. The tax applies even if the original contribution was made to a different spousal plan than the withdrawal.

This rule doesn’t apply if you and your spouse are separated and living apart when the withdrawal occurs.

How much tax will be withheld if I take money out of my RRSP?

The CRA requires all financial institutions to charge applicable withholding taxes on lump-sum retirement withdrawals in the same year. Unless you’re transferring the money to a registered retirement income fund (RRIF) or an annuity or taking advantage of the Home Buyers’ Plan or the Lifelong Learning Plan (LLP).

Upfront, expect to be hit with a 10% charge on the first $5,000, 20% on amounts between $5,000 and $15,000, and 30% on amounts over $15,000.

This amount is not your total tax liability; it’s just a down payment on what you owe. The money you withdraw is also added to all of your other income, which may result in another tax bite the following April.

At the same time, realize that you’re never going to get all your money upfront; no matter what you do, you will be taxed eventually — although usually at a lesser rate in retirement.

The RRSP deadline for 2020 contributions is fast approaching. Make sure to contribute any funds you plan to deduct on your 2020 taxes before March 1, 2021, or you will have to claim them next tax season.

This post was updated on February 24, 2021.

Gordon Powers

A long-time fund company executive, Gordon Powers now heads up the Affinity Group, a consulting firm focusing on retirement readiness. Gordon was a columnist for the Globe & Mail and Morningstar for many years and is also currently a columnist for Investment Executive, Canada’s national newspaper for financial advisors.

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