I hate alarmist, misleading headlines like the one above.
But you clicked it because Canadians have been brainwashed into believing that they should only contribute to their RRSPs (and TFSAs for that matter) with whatever is left their bank accounts after the Christmas splurge is over.
“RRSP Season” is a construct made up by Canadian financial advisors to artificially set a deadline in the hopes that you’ll save something at some point. The truth is that March 1st simply marks the point that you can count RRSP contributions back “against” your income in 2017. If that makes no sense to you, read on. If you want the full RRSP vs TFSA breakdown, click here. Remember that you can make contributions to your RRSP at any point throughout the year. You can wire money to a discount brokerage account whenever you wish to invest or set up an automatic investment plan with a robo advisor (where a certain amount will automatically be deducted from your bank account each month and invested in a portfolio that you’ve had help setting up when you open an account).
A recent study by Bank of Montreal (BMO) suggests that a full third of eligible Canadians aren’t planning to take advantage of their RRSP contributions. Of those, 40% cite not having enough disposable funds to make such contributions, while 23% say their extra savings will go towards servicing other debt/expense obligations.
The RRSP in a Nutshell
- RRSP contributions are made from “pre-tax” dollars. This means your taxable income is reduced to the amount of eligible RRSP contributions that you make
- What does that mean for you? Once again, at the risk of oversimplifying, if you earn $1,000 in taxable income, and you contribute $100 into your RRSP – you’ll only be taxed on $900 at your current marginal tax rate
- Once that $100 is in your RRSP, it grows tax-free for as long as it remains sheltered there. Consider the following math: If you are 25-years old today and start saving just $100 a month until you retire (at age 65), at a conservative 4% rate of return, you’d have a nest egg of $116,532 by the time you retire!That’s because your $100 every month grows tax-free inside your RRSP – taking compound interest to a whole new level!
- You don’t have to put that money into your Chequing account and let it stay there! Your RRSP can be invested in any number of ways, including through Mutual Funds, Exchange Traded Funds (ETFs), Guaranteed Investment Certificates (GICs), High Interest savings Accounts (HISAs) or direct investment in stocks and bonds
- This is an especially great vehicle for those wanting to invest in products that provide high returns (dividends, interest and capital gains) – because those earnings will grow tax-free inside the RRSP
- RRSPs are also a great savings strategy for current high-income earners who expect to be in lower income brackets during retirement. Why? Because when it’s time to withdraw that RRSP money (hopefully in your golden years when you’re likely to earn less and are in a much lower tax bracket) you’ll pay less tax on the amount withdrawn compared to what you would pay if you didn’t shelter it
- Each year, the government allows you the opportunity to “shelter” a maximum of 18% of your earned income or a predetermined maximum amount – whichever is lower. For the 2017 tax year (the one that you’ll be filing your tax returns later this spring) you can shelter up to a maximum of $26,010.
The great thing about starting RRSP contributions is that you don’t need to be of-age to start saving tax-free. Even if you are minor, say doing a paper run at age 14, you can have a parent/guardian provide a Letter of Consent… that’s enough to start the RRSP ball rolling. As long as you have earned income, and declare that income in your CRA tax return, you’ll start accumulating RRSP room (that you can hopefully use subsequently – once you get a “real” job!).
Putting Your RRSP “Tax Break” To Work
There are a number of pros of the RRSP as a retirement savings tool, and there are a number of ways to leverage the “tax breaks” that you may receive from using RRSPs. As small or as large as they might be, those RRSP “tax breaks” can be put to some good uses, including:
- Giving you a head start on next year’s contribution (for your 2018 Tax year)
- Paying down higher-interest debt, like a credit card balance or a personal loan installment
- Using it to make accelerated payments towards the principal owed on your mortgage, which will help you own your home sooner, and to pay off that mortgage with less interest
- Diverting the money into a Registered Education Savings Plan (RESP) for your child/ward, which could net you matching contributions (FREE money!) from the government
So, if you are one of the fortunate 47% of Canadians planning to make that RRSP contribution, then good for you! For the 36% who aren’t planning to take advantage of this opportunity, perhaps there’s still time to change your mind. Consider the following:
Regular contributions to this retirement savings vehicle will not only give you a head start on planning for life-after work, but it can help you reduce your taxable income now (as you continue to make those contributions), while also positioning you to pay less tax later (when you start drawing from your RRSP).
But there’s more to starting an RRSP. The government of Canada also allows you to put your RRSP savings to other tax-free/interest-free uses too, including:
- The Home Buyers Plan (HBP) – which lets you take a “loan” from your RRSP to buy your first home
- The Life-Long Learning Plan (LLP) – which allows RRSP money to be used for education and training programs
Of course, there are a number of caveats and restrictions to using RRSP savings for these programs. You need to make sure you meet all the prerequisites for these plans before you put your RRSP dollars to work for you.