RRSP season is in full swing. If you’re planning to put money into a Registered Retirement Savings Plan, the time to act is now.
Here’s a lot of what you need to know:
What’s the deadline?
This year, the deadline is March 1. You have until then to pump some funds into your RRSP and claim that contribution on your tax credit when you file your 2017 taxes later this year.
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What’s your contribution limit?
Building up your retirement savings is great, but mind the contribution limit. The government imposes strict caps on how much money Canadians can save in their RRSPs.
First of all, in order to be able to contribute anything at all to an RRSP, you need to have had earned employment income and have filed your taxes, Lisa Gittens, senior tax professional at H&R Block.
The maximum you can save into an RRSP every year is 18 per cent of your pre-tax earned income from the previous year, up to a ceiling that gets bumped up a bit every year. For 2017, that’s $26,010 (up from $25,370 in 2016).
However, if you’re lucky enough to have an employer-sponsored pension plan, your annual limit will be lower.
Now, the annual contribution limit is what you need to pay attention to if you’ve always made the maximum contribution to your RRSP.
If you haven’t hit your ceiling in previous years, one of the nice things about RRSPs is that you get a chance to catch up later.
WATCH: Starting early makes a big difference – even if you can’t save much
Carry forward rules
If you haven’t been maximizing your RRSP contributions, your ceiling is different than the annual contribution limit.
“The two are separate and it’s important to know the difference. We sometimes get clients who are confused about this,” Gittens said.
For example, if you were eligible to contribute, say, $10,000 every year since 2015, but didn’t put in a dime into RRSP, you could, in theory, pour in $30,000 all at once by March 1 and receive a blockbuster tax refund this year.
Look for your unused contribution room in the notice of assessment from last year. That’s the file the Canada Revenue Agency kindly sends every Canadian after it has assessed their tax returns.
Something to consider: You can contribute now and ask for the tax refund later
Many Canadians await eagerly for their RRSP refund. After all, it’s one of the few instances in which we get a reward for sticking to a long-term goal like saving for retirement. So why postpone that bit of short-term gratification?
Here’s the thing. The government uses your tax rate to calculate your RRSP refund. This means that for a given amount of dollars in contributions, you’re going to get more money back if you’re earning a higher income and are being taxed at a higher rate.
If you have a relatively low taxable income right now but are expecting your earnings to go up in the future, you could consider making a contribution this year but not claiming the deduction until you’re in a higher tax bracket, said Gittens.
You’ll get more refund bang for your contribution bucks. In the meantime, your savings grow tax-free inside the RRSP.
What happens if you overshoot the contribution limit
When it comes to RRSP contributions, too much of a good thing is bad. You’re allowed to overshoot your limit by up to a lifetime total of $2,000. The government will tax anything beyond that a penalty rate of one per cent per month.
If you think you’ve over-contributed to your RRSP, you should consult a tax accountant about addressing the issue.
What happens if you take money out of an RRSP
Think hard about how much you can truly afford to save into an RRSP because taking the money out in an emergency will cost you, Gittens warned.
RRSPs are meant to encourage Canadians to save for their old age, so the government isn’t keen on you making pre-retirement withdrawals.
There are a couple of exceptions. You can take money out of your RRSP tax-free if you’re buying your first home or paying for education or training expenses. But there are firm limits on how much you can withdraw – and you’ll have to eventually repay that money if you want to avoid tax.
In general, though, pillaging your RRSP funds triggers two tax consequences, according to Gittens. First, you pay an immediate tax that is withheld by your financial institution. For example, if you want to take out $15,000, you’d actually receive $12,000. The bank would remit $3,000, or 20 per cent, to the government as tax.
Second, the full amount of your withdrawal – $15,000, not $12,000 – would count as taxable income on your tax return. This would be added to any other money you’ve made that year, potentially bumping you into a higher tax bracket, noted Gittens.
Before committing to an RRSP, take a look at TFSAs
RRSP have a slew of advantages – but they aren’t necessarily the best retirement saving option for everyone. For more on that, look for the second instalment of our ongoing Money123 on Tuesday.