Anyways, February doesn’t just mean surprise weather conditions, it also means that you still have time to make your annual RRSP contribution to lower your 2016 taxes. The RRSP deadline doesn’t actually follow the calendar year, and to make it even more confusing, it’s not always even on the same date. Usually, it lands on March 1st, but the actual rule is that you have the first 60 days of the year to contribute to your RRSP for the previous tax year. This means that every four years a leap year comes along, and the deadline gets bumped up to February 29th…just to keep us all on our toes! And all you leap year birthday babies actually get to celebrate 😉
One way to get around the confusion and never forget the deadline is to STOP making annual, lump-sum contributions to your RRSP. No, I don’t mean skip your contribution…I mean make it an automatic monthly (or weekly, bi-weekly, semi-monthly…whatever) payment and never have to think about it again. The only thing to remember here is that pesky little 1st of the month. If you have your automatic contribution set to run on the first, every four years that March 1st payment won’t count for the previous year. Maybe save yourself that headache and set it to run on the 15th or even the 5th.
Each year you are allowed to contribute 18% of the previous years earned income, up to a maximum amount set by CRA. For 2016 that maximum was $25,370. You don’t lose your RRSP room, so if you have missed contributions from past years, you can catch-up at any time. The easiest way to check your current room is by looking at your ‘Notice of Assessment,’ it will be listed there. There are penalties to pay if you happen to go over your RRSP contribution limit. You do have a little leeway; CRA gives you a cushion of $2,000, but if you go over that then you’ll have to pay a tax of 1% per month on the excess amount. This will keep accumulating until you either withdraw the over-contribution or earn more room. Trust me, it’s a pain to fix so just don’t do it.
If you contribute to a group RRSP through your employer, then those contributions also count towards your annual limit. This also applies if you are contributing to a pension plan. You will see a ‘pension adjustment’ listed on your NOA that lowers the amount you can contribute.
Why an RRSP?
I’ve talked about the benefits to an RRSP before (find that here) but I’ll give you a quick recap. You might think that the biggest advantage of an RRSP is the refund it can give you when you file your taxes, but that’s not entirely true because you still have to pay tax when you withdraw the money down the road. The main benefit is that you can make a deposit to your RRSP when you are in a high tax bracket and then withdraw the funds in retirement when you are hopefully in a lower tax bracket. This is why it doesn’t always make sense to contribute to an RRSP, especially if your income is low at this point of your life. You’ll get the biggest advantage by contributing the most to your RRSP when you are earning at your highest level and then withdraw those funds when your income is at it’s the lowest level. Make sense? The money in your RRSP is also sheltered from tax until you take it out, so you won’t get any tax slips for earned interest or capital gains every year like for non-registered accounts.
One exception to the contribute during high income and withdraw during low income is if you are planning to take advantage of the Home Buyer’s Plan. This is a program that allows first-time home buyers to withdraw up to $25,000 tax-free from their RRSP to help them buy a house. I like the idea of saving your down payment (at least the $25,000 of it) in your RRSP because then you can use the tax refund to get you closer to your savings goal. You do eventually have to pay the money back into your RRSP over the next 15 years (and there’s no additional refund on the repayment amounts), but I know from my own experience saving up to buy a house that every single penny counts. If you’re buying your first home with someone else you can use the HBP for each person.
How much will you get back?
The refund you will get on your RRSP contribution is based on your income and marginal tax bracket. How it works is that your income for the tax year will be reduced by the amount you contribute, therefore lowering the amount of earned money you have to pay tax on. Take a look at the table below to figure out which tax bracket you fit into (these are Alberta rates but you can find other provinces here, and you’re looking for the federal/provincial combined rates).
Let’s say your income is $94,000 and you want to make an RRSP contribution of $5,000. Because you are in the 36% tax bracket, you would get a refund on the contribution of $1,800 (or lower the amount of tax you owe by that much). If you want to do a quick estimate on what you may owe (or get back) on your taxes and see the impact an RRSP contribution would have, you can check out the calculator from TurboTax.