Part 3 – RRSPs: A Savings Stalwart

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In the last two installments of our 5-part series, ‘Turning Tax Pain into Personal Gain’, we discussed a conceptual framework for thinking about taxes and improved our understanding of registered accounts and how they relate to tax planning. In this article, we drill down on Registered Retirement Savings Plans (RRSPs) and how to use them to maximize tax efficiency.

As a primer, RRSPs were created in 1957 and primarily offer Canadians an opportunity to defer and potentially reduce taxes over their lifetime. Contributions to RRSPs are made with pre-tax income (your taxable income is reduced by the contribution amount; no tax is paid on these contributions). 

The primary tax advantage of an RRSP is that contributions, up to the yearly deduction limit, are tax deductible in the year the contributions were made. The yearly deduction limit is 18% of your previous year’s reported income, up to a maximum of $27,830 in 2020. If you contribute, you can deduct the contributions from your taxable income, lowering your tax liability, often generating a tax refund.

The deadline to contribute to an RRSP and have it count for the 2020 tax year was March 1st, 2021. If you missed the deadline this year, however, all is not lost. As you will soon learn, RRSP contributions are not your only option and may not be right for everyone. Moreover, your RRSP contribution room will be available in future years if left un-used and may allow you to save more tax if you enter a higher income tax bracket in future years.  

Investment income (capital gains, dividends, interest) is not taxed inside your RRSP. There is no income tax reporting for RRSP accounts outside of tracking money flows in and out of the account. To determine if an RRSP will reduce your lifetime tax liability, you want to understand what your income will look like over your lifetime. For example, if income from all sources in retirement will place you in the same income tax bracket when you made the RRSP contribution (or worse, a higher one), the lifetime tax savings benefits of an RRSP will be limited. 

When money is taken out of an RRSP, it is added directly onto your taxable income in the year of the withdrawal. The year the RRSP holder turns 71 (though conversion can be done at any time), the account must be converted into a Registered Retirement Income Fund (RRIF) which requires a minimum withdrawal each year be paid out to the account holder, as taxable income. There is some flexibility with the frequency and amounts of these payments, but RRIFs must make minimum annual payments, and the minimum withdrawal percentage increases each year with your age. 

(For your reference, the 2021 RRIF withdrawal tables can be accessed here: https://www.taxtips.ca/calculators/rrsp-rrif/rrsp-rrif-withdrawal-calculator.htm, along with a useful calculator to estimate your RRIF payment). 

A potential complication for some is what happens to your RRSP/RRIF upon death as this triggers a deemed disposition and a winding down of the account. This results in the full value of the account being added to your taxable income on your terminal tax return. If you have large, registered accounts and are concerned about tax liabilities upon your passing, we encourage you to consult a tax professional to avoid leaving your beneficiaries with unexpected surprises.

As some general guidance, RRSPs are most useful for those in high income brackets, those without defined benefit or defined contribution pension plans and those who may have periods of unemployment in their working years. If you think you fall inside one of these groups, we recommend you further explore RRSPs, or discuss how best to use them with your financial professional. RRSPs also come with some limitations, primarily in your ability to access funds without triggering taxable events. If this is a concern for you, we encourage you to read our discussion about TFSAs which comes after the next installment in our series, 4 Ways to Access RRSP money.

Disclaimer

This information has been prepared by Dave Charlebois, Investment Advisor, and Stephen Gaskin, Associate Investment Advisor for Lighthouse Wealth Management, a division of iA Private Wealth Inc. and does not necessarily reflect the opinion of iA Private Wealth. 

The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered.

iA Private Wealth Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. iA Private Wealth is a trademark and business name under which iA Private Wealth Inc. operates.

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