What is an RRSP?
An RRSP is a powerful retirement savings tool you create that you or your spouse or common-law partner contribute to. These contributions to RRSP lowers your taxes.
The contribution in the RRSP (Registered Retirement Savings Plan) is invested so your savings grow. You do not pay any tax on the income earned inside the RRSP as long you do not withdraw from the plan.
It is heavily used for tax planning strategies to minize and defer personal tax.
How can an RRSP benefit me?
There are 3 significant advantages in contributing to RRSP.
- Your taxable income for the year reduces by the amount of contribution and, therefore, less taxable income = lower tax bill.
- The income earned on the contribution is not taxed until it is withdrawn.
- You are saving for your golden years.
There are other advantages to RRSP as well.
- RRSP Home Buyers’ Plan. Here, you and your legal partner or common-law partner can borrow up to $35,000 each from your RRSP to buy your first principal residence; however, it must be repaid within 15 years.
- Lifelong Learning Plan (LLP). The LLP lets you borrow up to $10,000 per year to a maximum of $20,000 tax-free from your RRSP for you or your spouse’ education or training; however, it must be repaid within 10 years.
Note: You cannot use the program to finance your children’s post-secondary education.
How does an RRSP work?
Let’s assume your taxable income is $125,000 a year and you plan to put $25,000 towards your RRSP. Your taxable income will now be $100,000. The tax savings on this contribution will be approximately $10,800 or around 43% of your contribution (calculations are based on 2021 marginal tax rates). This is HUGE tax savings! You can use these tax savings to invest and save further. This is where Tax Planning is crucial!
There is a limit to how much you can contribute towards RRSP per year. The contribution limit for 2020 RRSP is 18% of earned income from 2019, up to a maximum of $27,230. Similarly for 2021, the maximum amount is $27,830. You can “carry-forward” any unused contribution room.
Ideally, you will contribute to your RRSP account in your “prime years” where your earnings are high and these contributions to RRSP slashes your marginal tax rates. And you want to withdraw from RRSP in your retirement, when your earnings are minimal or lower than it is now and, therefore, it does not significantly increase marginal tax rates.
How do I set up an RRSP?
Opening an RRSP has never been easier. You can open an RRSP account online with many of the larger financial institutions. Alternatively, you can also visit your branch and do so in person.
I highly recommend you choose an investment advisor that you feel comfortable with to help guide you through the process. This is because, the contributions made towards RRSP are being invested in the market, and it is important that you decide what type of investments suit your financial goals and your risk appetite.
What is the penalty for an RRSP over-contribution?
For any over contribution to your RRSP plan, CRA will impose a penalty of 1% per month on the exceeded contribution amount. CRA allows a grace amount of $2,000, however, this is not tax deductible.
To resolve this:
- Pay the penalty on time
- Withdraw the excess amount
- Show that you contributed to a qualifying group plan
What is a Spousal RRSP?
You can contribute to your spouse or common-law partner’s RRSP up to your own contribution limit. You will receive the tax deduction for this contribution. The main advantage of this is if one spouse’s income is significantly higher than the other’s; this helps to balance the taxes paid by both individuals.
When the spouse with the higher earnings contribute to a spousal RRSP, it lowers their tax bill. And when the lower earning spouse withdraws from the RRSP, they will have to pay tax at a lower marginal tax rate. Huge tax savings can be found here.
To find out more about how RRSP will benefit you, call Oasis LLP and speak to one of our advisors. They will help you figure out the best way to maximize RRSP to reduce your tax bill.
The information contained within this blog is provided for informational purposes only and is not intended to substitute for obtaining accounting, tax, or financial advice from a professional accountant. Please Book an Appointment to discuss how information contained here pertains to you.
About Oasis LLP – Advisors and CPAs
At Oasis LLP we help business owners find what is at the end of the rainbow. With over 25 years of expertise in business advisory, accounting, auditing, and personal and corporate tax, we can help you navigate the accounting and tax world. We are located in Richmond Hill serving Markham, Richmond Hill, Vaughan, and Toronto.
