By Conrad Funk, CPA, CA
The Registered Retirement Savings Plan (RRSP) is a great tool for all levels of income. It is designed to encourage individuals to save for their retirement by providing them with a tax break upon investment. In theory, it moves taxable income to a period of time when the individual is not earning as much income, such as in retirement. This is defined as a positive net benefit.
For example, an individual making $100,000 in Saskatchewan will be paying tax at a high rate, 38%. By contributing to an RRSP, the individual will save $380 for every $1,000 contributed. In retirement, the same individual making $60,000 before RRSP withdrawals and paying tax at 33.5%, the individual will be paying $335 in tax on every $1,000 withdrawn. This example results in a positive net benefit of $45 for every $1,000 contributed and withdrawn.
Generally, individuals should only contribute to an RRSP if it will result in a positive net benefit. There are reasons to contribute to an RRSP if the tax paid on withdrawal exceeds the initial tax saved on contribution. Some of these reasons are listed below.
Reasons to contribute to an RRSP:
- Actually saving for retirement. Since withdrawing from an RRSP will be taxable income, it is less tempting for individuals to withdraw money than if it was in a non-registered account or a Tax Free Savings Account (TSFA). The earlier an individual can start contributing, the more they will have upon retirement as the longer it is sitting in a quality investment, the more time it has to grow.
- Company matches contributions. If an employer is willing to match employee contributions, it is important to take full advantage of this. At any income tax level, you are better off contributing and getting the company match, whether the money is left in the RRSP or withdrawn. For example, if an employee is in the 48% tax bracket, contributes $1,000 to an RRSP and the company matches, the individual is left with $2,000 in an RRSP that cost $560 ($1,000 contribution less 48% tax savings of $480).
- Saving for a house. Individuals can withdraw from an RRSP to purchase a house tax-free under the Home Buyers Plan (HBP). Since RRSP contributions are made with pre-tax income, the easier it will be to save for a house purchase. Individuals will have to re-contribute the money withdrawn over 15 years starting in the 2nd year after withdrawal. If the annual repayments to the RRSP are not made, there will be tax consequences.
- Saving for education. This is the same idea as saving for a house – since contributions are made with pre-tax income; it is easier to fund education or training. The Lifelong Learning Plan (LLP) must be re-contributed over 10 years starting in the 5th year after withdrawal in most situations. If the annual repayments to the RRSP are not made, there will be tax consequences.
- Increase certain non-taxable benefits. Certain programs such as GST credits, the Working Income Tax Program (WITP) and the Canada Child Benefit (CCB) program are calculated based on individual’s net income. By contributing to an RRSP and reducing net income, individuals can increase payments from these programs.
- Become eligible for certain low-income programs. Certain low-income programs can become applicable if an individual contributes to an RRSP. Programs such as the Government of Saskatchewan Family Health Benefits program are available if family net income is below a certain level (currently approximately $30,000 for that particular program). If a family has net income slightly above the threshold, an RRSP contribution can be a tool to qualify for these types of programs.
- Reduce Old Age Security (OAS) clawback. Individuals that are between 65 and 71 receiving OAS with net income over the clawback threshold can reduce this clawback by contributing to an RRSP. Individuals can contribute to an RRSP through December of the year they turn 71 (or contribute to a spouse’s RRSP that has contribution room if they are over 71 and the spouse is under 72). Clawback starts at approximately $75,000 and is clawed back by 15% until it is completely eliminated at approximately $120,000. RRSP contributions net an additional 15% savings as this is the rate at which the OAS is clawed back.
- Transfer future income from a higher income earner to a lower income earner. If a couple has one spouse that will make a higher level of income in retirement than the other, a spousal RRSP should be considered. When an individual contributes to a spousal RRSP, that individual will get the RRSP deduction, but the spouse will get the RRSP and its future withdrawals. In retirement, the lower income earning spouse can withdraw this money and, in theory, pay less tax than the higher income earning spouse. Of note, the RRSP cannot be withdrawn within three years of contribution or the income will attribute back to the contributor.
Finally, an example of how an RRSP contribution for family making moderate income could be beneficial.
A married couple has 3 children under the age of 18 and live in Saskatchewan. Spouse A made a $50,000 wage in 2016 and Spouse B worked only part-time and made $5,000 for a total family income of $55,000. This family would like to know how much they could receive in tax savings and government programs by contributing $1,000 to an RRSP.
The RRSP contribution is made with pre-tax income, so the tax savings and increase in government programs is money in their pocket. In this situation Spouse A should contribute to a spousal RRSP if Spouse B will expect to have lower earnings in the future and in retirement, so withdrawals can be taxed at a lower tax rate. Spouse A is currently paying tax at 33.5% in Saskatchewan so the contribution will save $335 in taxes. The family will also receive 19% more in Canada Child Benefit payments and 7% more in GST credits. This example provided this family with an initial return of $595 on the $1,000 contribution. Essentially, the $1,000 RRSP contribution only cost them $405.
For RRSP planning and advice, please contact any of our trusted advisors or tax professionals.
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