Why the RRSP May Be Our Most Important Tax Planning Tool

It’s more than just a retirement savings account.

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Most people know the Registered Retirement Savings Plan (RRSP) as the must-use retirement savings account. But did you know that the RRSP is a powerful tax planning tool, too? With the February deadline for RRSP contributions fast approaching, now is a good time to look at the RRSP from a tax planning perspective.

When you contribute to an RRSP, that money is tax exempt for as long as you keep it in the plan and, even better, your contributions will reduce your overall tax burden each year. “Individuals are taxed on their net income, which is equal to the person’s total income minus certain deductions, including a deduction for contributions made to an RRSP,” says David Ablett, Investors Group’s Director of Tax and Retirement Planning. “That can result in significant tax savings.”

When you contribute to an RRSP, that money is tax exempt for as long as you keep it in the plan and, even better, your contributions will reduce your overall tax burden each year.

For instance, a single person living in Ontario, who has a total income of $120,000 with no deductions, will pay combined federal and provincial tax of $33,409. If they contribute the most they can to their account, which in this case is 18 percent of their earnings or $21,600 (for people making above $150,000, the max is $26,010 for 2017) then the person’s net income will be reduced from $120,000 to $98,400 and the tax owing would be $24,032. The RRSP contribution has reduced their tax owing by $9,377.

Ablett also provided these examples of tax savings for maximum RRSP contribution at higher levels of income:

Depending on your tax rate when you contribute and, later, withdraw, it can be a good idea to put your RRSP tax refund into a Tax-Free Savings Account (TFSA), in part because TFSAs are more flexible than RRSPs. “You can save up to $5,500 tax-free in a TFSA each year and withdrawals are also tax-free,” he explains. “So, if you need quick money for an emergency or larger purchase, taking it from a TFSA will not trigger a tax hit but taking it from your RRSP will.”

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A spousal RRSP is another potential tax-planning tool for higher income Canadians. These accounts are in one spouse’s name – often a lower income earner – but the other, higher earning spouse can contribute and receive the tax deduction for use on his or her taxes. “This will reduce the contribution room of the higher earning spouse, but when the RRSPs are accessed in retirement, there will be two smaller incomes instead of one big income so the couple will save on taxes,” says Ablett.

It’s important to know that an RRSP is more than a place to put your retirement dollars – it can reduce how much you hand over to the government, too. “It’s always a good strategy to get your RRSP and TFSA working together to not only fund your retirement goals but also as effective tax-planning tools,” says Ablett.

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