It’s almost RRSP season again! If your RRSP savings aren’t on autopilot, you are probably thinking about contributing to your RRSP before the March 1 deadline. How much should you invest?
For the 2017 tax year the RRSP limit is 18% of your 2017 gross income, or $26,010, whichever is less. Is that how much you should save? What if you can’t save that much? And what about your TFSA?
We can help answer those questions below. Want to use online tools and do it yourself? Check out the free tax calculator at SimpleTax to see the taxes you might pay on your income and save by making an RRSP contribution.
How much should you contribute to your RRSP in 2018? First, let’s cover some basics
An RRSP is an account type designed to help us save for retirement. It works very differently in the 3 stages of your financial planning life cycle that we call accumulation, income and estate.
During the accumulation stage, we can save a part of our gross income (before income taxes) and defer taxes on all investment income and gains. The contributions we make reduce our taxable income dollar-for-dollar. This means when we contribute to an RRSP using after-tax income, we will not have to pay income tax on that income!
If we withdraw any funds from our RRSP during this stage, we will have to pay income tax on the amount. This applies just as if we earned that income from our job. Even worse, we will lose that RRSP contribution room. However, there are two exceptions to this rule: withdrawing funds paying into the Home Buyers’ Plan (to help with down payment on your first home) and Lifelong Learning Plan (to help pay for post-secondary education).
Rolling over your RRSP into a RRIF
The income stage starts when we retire and start to make income payments to ourselves from our RRSP (usually after converting to a Registered Retirement Income Fund, or RRIF).
These income payments are taxed just like regular income (as are some of our other sources of income in this stage, like CPP, OAS and other retirement benefits).
Your RRSP must be converted to a RRIF by December 31st of the year you turn 71. A RRIF is also subject to minimum withdrawal requirements.
During the estate stage (after we pass on), our RRSP can roll-over to our spouse with no immediate tax consequences. Once your surviving spouse also passes on (or if you do not have a spouse), your entire RRSP (or RRIF) amount is treated as income to your estate.
For example, if someone dies with a $300,000 RRSP in Ontario without a spouse, their estate will have a tax liability of ~$124,399 or more due to the RRSP.
So, when you use an RRSP, it is important to consider how the RRSP works at each stage. That way, we do not over-optimize for one stage only to botch another. Remember:
• To maximize tax savings over your lifetime, make sure that your marginal tax rate when you contribute is higher than your average tax rate in retirement. This TFSA/RRSP comparison calculator can help illustrate this.
• If you are in a lower tax bracket now and expect to be in a higher bracket later in your career, consider using a TFSA until you are in a higher tax bracket.
• To avoid significant RRSP taxes in your estate stage, only save enough in your RRSP to provide your lifestyle income until age 100 (at the latest). You want to minimize extra RRSP money at estate time.
• If you’ve saved too much in your RRSP in the accumulation stage and now your RRIF is providing more income than you need, you should save the extra money coming from your RRIF in a TFSA or non-registered account.
Keeping all of this in mind when planning your RRSP contributions will help you get the most out of your money. That way, you’ll pay the least taxes over your lifetime.
So… how much should you contribute to your RRSP in 2018?
Tying back to the original question of how much to contribute to an RRSP, what is the million-dollar answer? Enough to cover your lifestyle needs until age 100.
What if you can’t save that much? Then you will need to spend less when you retire or save more before retirement when your income increases.
If you set a savings plan and work towards a retirement goal, you can keep the same lifestyle you have today.
What about the TFSA that we mentioned earlier?
You should use your TFSA when you’ve saved enough in your RRSP to cover your lifestyle needs in retirement, and for other savings goals.
Adjusting RRSP contributions
If you start making more money, you should make an adjustment to your savings to keep on track. This review is only needed every couple of years, or when you get a major salary increase.
Don’t forget inflation
Inflation can eat into your savings pretty quickly. If you don’t adjust your savings for inflation, your dollar amount may have a different purchasing power when you spend it later in life than it did when you saved. It is important to increase your savings over time with inflation.
Pro Tip for RRSP contributions
The absolute best way to save is to automate deposits to your RRSP on a regular basis, lined up with your payroll. That way, as soon as money comes in, some goes out to savings. If you set up an automatic RRSP savings plan, you should file form T1213 with the CRA and they will have your employer reduce the income tax coming off your pay so that you get your money back as soon as possible.
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