Financial Management

RRSP ’s: What You Need To Know

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02/13/2019 – By Jason Smale

Why set up an RRSP

Canadian’s are given a unique retirement investment vehicle which doubles down as a tax savings plan. Here we are not discussing the popular Tax-Free Savings Account, but rather a Registered Retirement Savings Plan.

Registered Retirement Savings Plans differ from Tax-Free Savings Plans in that they provide a vehicle for making tax-deductible contributions. RRSP’s provide a vehicle for tax deferral strategies. An individual making RRSP contributions in the current year receive tax relief by investing their earnings at a time in life when their earnings are taxed at a higher rate.

How an RRSP works

RRSP’s are registered with the Canada Revenue Agency, and each Canadian taxpayer has an annual contribution limit. The contribution limit is determined using a formula that caps the amount of credit you can receive for contributing to your RRSP’s annually.

The contribution limit is calculated using a formula which is the lower of 18 percent of your prior year’s earnings, or an indexed amount per year. In 2018, the indexed rate for contribution limits to an RRSP was set at 26,500. If you have not maxed out your contribution limits in prior years, the unused portion carries forward to the current year.

Earnings within an RRSP grow tax-free! There are no capital gains or interest earnings to declare from investments made within an RRSP. However, the contributed amount will be taxed upon withdrawal. In most cases, the withdrawal will take place during retirement when you have a lower income and will be taxed at a lower rate.

Types of RRSP

Individual plans are set up in the name of the contributor with a financial institution who walks the investor through various investment options by determining their level of risk, duration of investment and future goals.

Spousal RRSP contributions allow for a form of income splitting between partners, this is typically done where the higher income spouse will deposit funds into an RRSP in their partners name and receive the tax-deductible credit on their earnings, while allowing the partner to withdrawal the funds in retirement where they are likely to maintain a lower income tax rate.

Self-directed plans allow RRSP holders to manage the investment within side the plan themselves, rather than an institution like a bank handling the funds.

Group plans can be offered as part of a benefit plan through your place of employment, some companies provide benefits to employees like matching contributions, and others leave the employee solely responsible for the contribution.

Corporate Earnings: Salary vs. Dividends

Individuals who own shares within their own Canadian Controlled Private Corporation have the option to elect to receive remuneration from the corporation in various ways, the two most popular methods include receiving salaried income or dividend income.  Individuals choosing to receive a salary are considered to have received “earned income” in the current year and are eligible to contribute to RRSP’s while receiving the tax-deductible credit, while those receiving dividends only, are not considered to have received “earned income” and therefore do not qualify to receive the tax-deductible credit associated with RRSP investments.

The wisdom of a professional accountant would dictate that the owner of the CCPC withdrawal enough earnings in the form of salary to maximize their RRSP contribution limits in the current year and take the remaining amount in the form of dividend income.

Effects of turning 71 – converting to a RRIF

RRSP to a Registered Retirement Income Fund, and instead of contributing to the RRSP you now begin withdrawing funds from the RRIF. Some advanced tax planning strategies can be employed in the year you turn 71 if you’ve continued receiving earned income in that year. The tax planning strategy allows you to use the contribution room the following year while taking a 1% penalty for investments over $2,000, the next year the contribution is no longer considered to be in excess and can be deducted from that year’s taxable earnings.