This year Canadians have an added incentive to contribute to their registered retirement savings plans (RRSPs) by the March 1 deadline: larger-than-usual tax balances.
Those who have received the Canada Emergency Response Benefit (CERB) and other federal COVID-19 income supports may experience tax shock this spring because Ottawa withheld little or no tax at source on those payments. Even workers who have been on Employment Insurance (EI) during spells of unemployment may be in a similar situation if the government didn’t deduct enough tax from their cheques.
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Contributing to an RRSP by the beginning of March allows Canadians to lower their taxable income for the year 2020, which can trim their tax bill this spring.
“If you received the (COVID-19) benefits maybe you can put some money aside into your RRSP, because deductions … will reduce your tax owing,” says Lisa Gittens of H&R Block.
“It’s not dollar-for-dollar coming off your balance owing, but it’s going to reduce it somewhat and you still get to keep the RRSP (contribution),” says Jennifer Gorman at Turbotax Canada.
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But before you put money into your RRSP, take a look at your broader financial situation, says Liz Schieck, a certified financial planner at The New School of Finance.
While a “strategic” RRSP contribution might make perfect sense for some this year, that may not always be the case — even if you have a hefty tax liability.
How RRSP contributions work
An RRSP is a special kind of account that can help you save for financial goals and especially retirement. Unlike your plain-vanilla savings account, where any interest you receive is subject to tax, any interest or investment gains your money earns while sitting inside an RRSP is sheltered from tax. However, you’ll have to pay tax when you take funds out of the RRSP.
Anyone who has earned income and files a tax return can open and contribute to an RRSP up until the end of the year they turn 71. You can contribute a maximum of 18 per cent of your earned annual income, up to a dollar ceiling that’s set at $27,230 for the 2020 tax year. Any unused contribution room builds up year over year.
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Your RRSP contributions are tax-deductible, and if you put money into the account within the first 60 days of the year (usually by March 1 or Feb. 29 in a leap year) you can claim those funds as a tax deduction for the previous tax year. This can lower your tax balance for that year or generate a refund.
How to decide whether to contribute
The ability to reduce your bill for a given tax year is a nice perk of RRSP contributions but shouldn’t be primary consideration when you’re thinking about whether you should put money into the account, says Schieck.
Where the RRSP “really shines” is in a scenario in which you’re in a high tax bracket when making contributions and expect to be in a lower bracket when making withdrawals. That means you’ll be getting a big tax break when you put the money in and won’t have to pay as much tax when you take funds out, presumably in retirement.
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But if you’ve been receiving COVID-19 benefits this year, chances are your income is going to be lower than usual and so will be the tax deduction from your RRSP contribution.
“It may not be the best bang for your buck,” Schieck says.
For example, with a taxable income of $100,000 a $5,000 RRSP contribution would result in tax savings of $2,057 for an Ontario taxpayer, according to the 2020 RRSP Savings Calculator provided by EY. But the same $5,000 deposit to an RRSP would generate just $1,289 in tax savings for someone with a taxable income of $50,000.
Schieck suggests looking at your total income for 2020 and your overall financial goals when deciding whether and how much to contribute to an RRSP.
“If you have a financial planner or an accountant that you can ask for advice before the deadline, I highly recommend that,” she said via email.
The first step, she says, is to make sure that your short-term needs are covered. If you expect a lot of tax owing, for example, make sure you’d have enough money to pay for it even after contributing to your RRSP.
“You would have to contribute significantly more than your tax bill in order to erase taxes owing,” Schieck wrote.
You’ll also want to have enough cash savings set aside for a financial emergency, she adds. Similarly, if you foresee any large expenses coming up, make sure you’ll be able to pay for them. And if you are carrying high-interest debt you may want to use your spare cash toward that.
“It’s important to take stock of these kinds of things before making that contribution, to make sure you’re making a decision that’s right for you,” Schieck wrote.