Tax Savings and RRSPs

Many of our clients use Registered Retirement Savings Plans (RRSPs) as one of the pillars of their wealth building strategy. An RRSP is a type of retirement savings plan that is registered with the Canada Revenue Agency. It is simply a type of investment account that you establish with your advisor that offers two important tax advantages. 

Tax Advantage No. 1 

Contributions are tax-deductible when you contribute to an RRSP. You will receive a tax deduction for the amount of the contribution and you can use this deduction to lower your current taxable income. When contributing to your RRSP, it is important to consider your marginal tax rate. Canada has a progressive or "escalating" tax system so the higher your marginal tax rate, the greater benefit you will receive from the contribution. For example, if your marginal tax rate is 43%, then a $10,000 RRSP contribution will allow you to defer approximately $4,300 in taxes. As your marginal tax rate decreases, so does the benefit from the RRSP deduction. 

Tax Advantage No. 2 

Contributions to an RRSP can be used to purchase a wide variety of investments such as stocks, bonds, mutual funds and GICs. Normally, you would have to pay tax on your investment earnings on an annual basis. In an RRSP, the growth on your investments is tax-free, which leads to more growth and greater compounding. 

When you withdraw funds from your RRSP account, the amount withdrawn will be taxable. Ideally, you will contribute to your RRSP when your marginal tax rate is high and withdraw the funds when your tax rate is low. If you are currently in a low tax bracket and you expect your salary to increase in the future, you may want to consider contributing to your RRSP now to take advantage of the tax-free growth but delay claiming the deduction until your earnings are higher. 

How to Save and Improve your Cash Flow

If you find it difficult to save up a lump sum contribution for your RRSP, consider setting up an automatic savings plan. This is a type of "pay yourself first" savings method, whereby you setup automatic withdrawals from your bank account to your RRSP on a regular basis such as bi-weekly to coincide with your pay cheques. 

Rather than waiting for your tax refund once the savings plan is established, you can apply to the CRA to reduce the income tax withheld by your employer. This will prevent you from overpaying your income tax throughout the year and then waiting for your refund the following year. 

If you don’t have the cash to make a contribution, consider contributing securities from a non-registered account and making a contribution in kind. 

Tax Refunds 

If your RRSP contributions do result in a tax refund, it is important to keep in mind that this is not a windfall from the government. The tax refund actually represents the deferred tax that you will eventually need to repay to the government when you withdraw the money from your RRSP. Consider using your refund as a head start on next year's RRSP contribution, contributing to a Tax-Free Savings Account or paying down debt. Like all investment decisions, the tax advantages of RRSPs should not necessarily be the driving factor in your decision-making process. Every person’s financial priorities are different... for instance, you may have high-interest credit card debt that should be paid off first or you may belong to a matching company pension plan that is not being fully utilized. You and your advisor should review your entire financial situation in order to assess if contributing to an RRSP is the best use of your money. 

For more information on RRSPs and to tailor a plan that works best for you, you can contact your Rogers Group Financial advisory team. 

The deadline for RRSP contributions for the 2013 tax year is March 3, 2014.