Many Canadians already know that a Registered Retirement Savings Plan (RRSP) is a valuable – and versatile – retirement planning tool, but there’s more to these accounts than meets the eye.
Here’s what most of us do know: RRSPs are typically used as a long-term savings vehicle. The money we put in grows tax free until we take those dollars out in retirement, when our savings are taxed based on our personal income tax rate. Contribution room is based on income level and those who do put money into the account generally see a tax refund.
1. You can – and maybe should – delay taking your tax deduction
People tend to claim their RRSP deduction because they want to receive that tax refund. But those who anticipate being in a higher tax bracket in the next few years may want to wait. You’ll still invest those dollars, but you’ll claim your deduction in the future, when your income is higher. Why? Because the higher the income bracket, the higher the tax savings rate. For instance, in Manitoba, a person with an income of $25,000 who claims a $5,000 RRSP deduction saves $1,290 in tax, which is a savings rate of 25.80%. If the person waits to claim the deduction until a following year when the person’s income is $50,000, the tax savings on the $5,000 deduction is $1,662, which is a savings rate of 33.25%.
2. You may be allowed to take money out of RRSPs early – and not just to help fund the purchase of a new home
It’s fairly well-known that, thanks to the Home Buyers’ Plan (HBP), people can take up to $25,000 out of their RRSP tax free to buy a house, though they do have to repay that “loan” within 15 years. What most people don’t realize is that they can also take out money under the Lifelong Learning Plan (LLP), which is intended to help adults pursue their educational goals. Like the HBP, the LLP requires that borrowed funds be paid back on a scheduled payment plan. The differences are that under the LLP, you can withdraw up to $20,000 over a four-year period (with a limit of $10,000 per calendar year) and that it must be repaid over a period of 10 years.
3. Your spouse can claim some of your income as their own
For many years, the spousal RRSP was the only registered plan that could provide income splitting opportunities for couples. However, in 2007, the Canadian government introduced additional pension splitting on payments from registered pension plans and Registered Retirement Income Funds – which RRSPs eventually turn into – where the recipient is at least age 65. The change was designed to benefit families where one spouse earns significantly less than the other. “While spousal RRSPs continue to provide for income splitting opportunities, any RRSP, once converted to a RRIF, provides for income splitting after age 65,” says Dave Ablett, Investors Group’s Director, Tax & Retirement Planning.
4. The RRSP should not be your only savings account
RRSPs and TFSAs work best as a team to cover all of your short- and long-term savings needs. “The RRSP is an excellent long-term savings plan, but one weakness of the RRSP is that it’s fairly punitive if you need money for an emergency,” says Ablett. “The RRSP was never designed as an emergency fund. If you need $10,000 suddenly, take it out of your TFSA.”
Usually, it makes sense to invest in an RRSP when your income is taxed at around 25% to 30%. If you’re in a lower income bracket, you may want to use the TFSA as your main savings account. A professional can help you decide what to do, but if you can use both then that’s likely the best option. “We would recommend that you view the RRSP and TFSA as working together to fund your retirement goals,” says Ablett.
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