The importance of your RRSP cannot be overemphasized. One single wrong move and you pay more taxes than you should. That is why Ottawa Certified Financial Planners advocate that you take time to understand and get it right because it will serve as a reliable post-retirement income source.
This article discusses the RRSP contributions at length, focusing on who can contribute, how to contribute, and how to get the best out of your contributions.
Who is eligible to contribute to an RRSP?
You are eligible to contribute to an RRSP if you earn income, have a social insurance number, have filed a tax return, or have an RRSP contribution room available to you. When it comes to age, you cannot contribute to an RRSP once you are 71 years old.
How can you contribute to your RRSP?
Assuming you met the criteria outlined above, the next step is to contribute to your RRSP. You can choose to follow either the long-term or short-term approach in doing this.
The short-term approach allows you to contribute as much as you can to your RRSP every year. The more you contribute, the bigger your tax deduction. The benefit only lasts for the moment; it may cost you when you retire.
Your RRSP is automatically converted into a Registered Retirement Income Fund (RRIF) when you turn 71. However, you can have it done sooner before you turn 71. Once the conversion happens, you must withdraw a minimum amount from your RRIF annually – this will be your income. So, how much you have to withdraw from then depends on how much you contribute now.
An important note: if your minimum withdrawal amount is higher than what you live on as a retiree, the unspent income automatically puts you into a higher tax bracket. That means you will forfeit some of your savings as taxes.
The long-term approach is designed to assess both your current and retirement needs. So, it would help if you determined how much you will live on after retiring, and this will guide your decision on how much to contribute. The goal here is to ensure there are no excesses. Ottawa CFPs often advise contributors to estimate this assuming their retirement will last until age 100.
If there is any excess in savings, it goes directly into a The Tax-Free Savings Account (TFSA). Withdrawals from the TSA are not taxed, putting you in a lower tax bracket post-retirement.
Automatic RRSP Contributions
The best way to avoid overtaxing is to adopt automatic deposits. Automating your deposits into the RRSP regularly according to your payroll ensures you are not overtaxed. Once your income increases, adjust the savings to stay on track. The review should be done periodically, e.g., annually, or whenever your salary increases significantly.
Getting The Best Out Of Your RRSP
RRSP contributions go just beyond putting money away for your retirement. Over time, you can optimize your tax savings to get more out of it. Here are some helpful tips in that regard;
– Keep your contribution marginal tax rate higher than your average tax rate when you retire. Choose the most suitable account type based on your estimated marginal tax rate.
– Your RRSP savings should only be targeted at supporting your lifestyle until you clock at least 100.
– If you plan to leave some inheritance for your loved ones, you shouldn’t do that via an RRSP. Instead, consider a TFSA or a non-registered account that absolves you of taxes.
– If your RRSP savings are too much and you are getting more income than you require out of your RRIF, the extra money should go into a TFSA or non-registered account as savings.
The $2000 Overcontribution Cushion
In some cases, contributors may go over their RRSP contribution room. That is why the CRA offers a cushion of $2000. That means you can contribute an extra $2000 more than your maximum limit every year without any sanctions.
Some people take advantage of this $2000 and use it as an additional space. This is not a safe practice. Doing that means you have zero room for error, and any overpayment will come with severe penalties. For example, if you exceed the $2000 cushion limit, you will pay 1% on the excess amount.