If you’re still procrastinating about making an RRSP contribution for the 2018 tax year, then it’s time to get moving. The deadline is this Friday, March 1st. It’s a weird rule that’s only applicable for RRSP’s. Instead of running by the calendar year, you always have the first 60 days of the following year to make your contribution count. And trust me when I tell you that if you’ve been procrastinating, you are not alone.
Now you know when you need to make your contribution, but do you know if an RRSP is the best option for you this year?
The RRSP Advantage
Ask just about anyone the biggest advantage of an RRSP contribution, and they’ll likely say the tax refund. And yes, that’s a nice perk, but it’s not the number one reason you should be using your RRSP. You don’t pay tax when putting money in (hence the refund), but you do pay that tax when you withdraw that money. That means to get the most significant benefit from your RRSP is getting a refund when you’re in a high tax bracket and withdrawing when you’re in a low bracket.
RRSP Contribution Checklist
Before making an RRSP contribution, there are a few guidelines you want to follow.
1. Long Term Savings
Registered Retirement Savings Plan has ‘retirement’ right there in the name because that’s what it’s meant for. This isn’t where you save your emergency fund, or for an upcoming trip, or for any other short term savings goal. The money you put in your RRSP should be there for the long haul. The one exception is if you are saving to purchase your first home, but we’ll get to that in a minute.
One of the benefits of having money in an RRSP is you get tax-deferred growth. That means that your money can grow and you won’t have to pay tax every year. Any money that is in a non-registered account will be taxed every year if you earn dividends, income or capital gains. That tax-deferred growth is an advantage because the goal is that when you pay tax on withdrawals, you’ll be in a lower tax bracket.
The longer your money has to reap the benefits of compound growth the better an RRSP will be.
2. High Income
As I mentioned above, the best time to contribute to an RRSP is when your income is at it’s highest point. If you are a college student who is working part-time, you will be earning RRSP room, but it’s not going to make much sense to use the contribution. Let it build up and carry-over and take advantage when your income increases.
Here are the current tax brackets for Alberta:
2019 Tax Brackets (Alberta)
|Income||Tax Rate on Income|
|$0 - $12,069||0.00%|
|$12,070 - $19,369||15.00%|
|$19,370 - $47,630||25.00%|
|$47,631 - $95,259||30.50%|
|$95,260 - $131,200||36.00%|
|$131,201 - $147,667||38.00%|
|$147,668 - $157,464||41.00%|
|$157,465 - $209,952||42.00%|
|$209,953 - $210,371||43.00%|
|$210,372 - $314,928||47.00%|
If you are earning less than $47k per year and hope your income in retirement is higher, it will likely make the most sense to delay RRSP contributions and focus on your TFSA. Staying in the same bracket isn’t the worst thing because you at least get the tax-deferred growth, but it still makes sense to max out your TFSA first. In Alberta, our lower tax brackets are so wide that it can make RRSP planning a challenge. It’s not that unusual to stay in that 30.50% tax bracket your whole life.
3. First-Time Home Buyer
The exception to traditional RRSP rules is if you are saving to buy your first home. We have a program here in Canada called the Home Buyer’s Plan that allows first-time buyers to withdraw up to $25k from their RRSP’s with no tax. You contribute, get the tax deduction, get the tax-deferred growth, and pull the money out without the normal withholding tax.
With home prices as high as they are, every single penny counts when you are saving up that downpayment, so I love the idea that you can boost your tax refund by using your RRSP. I did this when I was saving for our first place and let me tell you, the extra money from that refund came in very handy.
You do have to pay the money back to your RRSP and you won’t get a second tax break on the deduction, but I still recommend the program. The government gives you 15 years (starting the second year after you make the withdrawal) to pay the full amount back. If you withdraw the full $25k, you will have to contribute $1,667 per year for 15 years. Make sure you budget for that going forward. Any contributions you make above that can either be applied as extra payments towards the HBP balance or treated as regular RRSP contributions (aka they’ll get you the refund.) There’s really no advantage to paying your HBP amount early. You pay no interest on the ‘loan,’ and there’s no early payment credit.
If you are unable to repay annual amount it will count as an RRSP withdrawal, included as income for the year and taxed. If the reason you can’t make the payment is that your income is low, then your tax rate would be low and the impact might be negligible.
If you’ve read through the three checklist points and none apply to your situation, then an RRSP contribution likely doesn’t make sense this year. Where you save your money depends on what that money is for. If you are building up an emergency fund or saving for a short term expense, then a high-interest savings account is your best bet.
Maybe you’re dealing with the tax bracket issue, and the plan is for your income to increase over the next few years. Saving your RRSP contribution room for when you get that raise can make a lot of sense, but where do you save now? A TFSA is the best option for this. You won’t get the tax deduction, but you’ll get tax-free growth and a lot more flexibility than an RRSP can offer. When your income increases in the future you can even move money from your TFSA to your RRSP. As of 2019, the total TFSA contribution room is $63,500. That’s assuming you were at least 18 when the program started in 2009 and a Canadian resident. Maxing out your TFSA should be your top priority if you don’t check off the boxes for an RRSP.
My income puts me in that 30.5% tax bracket. I hope to bump up into the next bracket eventually, but for most of my working life, I’ve been sitting in the same bracket. It’s also very likely I’ll remain there throughout retirement. Because I’m still young and my retirement savings have 20+ years grow I am making RRSP contributions for that tax-deferred growth benefit. However, I also contribute an equal amount every month to my TFSA. Best of both worlds.
What is your strategy for saving for retirement? Are you all RRSP, all TFSA, or a little bit of both?
This post was proofread by Grammarly.