RRSP Checklist
· The RRSP deadline is February 29, 2012.
· To qualify as a 2011 deduction, contributions to your personal or spousal RRSP must be made on or before February 29, 2012.
· Determine your RRSP contribution limit for 2011 by referring to your previous year’s Notice of Assessment from the Canada Revenue Agency (CRA), or visit the CRA website at www.cra-arc.gc.ca.
· Determine how much, if any, you have already contributed to your RRSP for 2011.
· You can take advantage of any unused 2011 RRSP room up to your contribution limit. You will be entitled to a 2011 tax deduction for this amount as long as the contribution is made by the February 29, 2012 deadline.
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How do I set up an RRSP?
“Setting up an RRSP can be as simple as opening up a bank account,” explains Chartered Accountant Carmelo Linardi, of Carmelo Linardi Professional Corporation in Aurora.
“RRSPs are special tax-deferred savings plans that must be administered by qualified financial institutions such as banks, trust companies and insurance companies. These financial institutions are responsible for ensuring these tax-deferred plans meet and maintain very specific guidelines.”
Certain information is required – your Social Insurance Number (SIN), the type of plan you want to set up, and the beneficiary of the plan should something happen to you before you have withdrawn your funds on retirement.
“The type of plan you choose can be as simple or as complicated as you like,” explains Linardi. “While an RRSP generally provides the same investment choices as a non-registered plan, you can start out by making a straightforward investment such as a GIC or basic interest account.”
Many employers offer group RRSP plans. Certain amounts are typically withdrawn periodically from your pay and contributed to the group RRSP – making saving and contributing easier. The main difference between a group RRSP and one you set up yourself is that, in many cases, a group RRSP has a set number of investment plans. If you set up your own RRSP, you can tailor your plan to your own needs and goals.
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Save for an RRSP
An RRSP is one of the best savings and tax-deferral programs available to average Canadian taxpayers. But coming up with the money to contribute can be a challenge, especially in a tough economy.
“People who learn to save when they’re young are better off financially as adults,” says Shailendra Jain, a Chartered Accountant in Etobicoke. “And when it comes to RRSPs, any contribution is better than no contribution.
“One of the best strategies for saving is setting up an automatic withdrawal system at your bank,” Jain suggests. “Have a fixed amount of money transferred from your bank account to your RRSP every payday, before you have a chance to spend it.”
Whether it’s shoes, CDs or some other kind of indulgence, we all have a “latté factor” – some secret way of spoiling ourselves and a likely place where we can cut spending and start saving.
“Remember that even small acorns can grow mighty oak trees, and the amount you save is not as important as getting into the habit of saving,” says Jain. “Borrow books and magazines from the library instead of buying them. Bring your lunch to work, entertain friends at home and take the kids on a nature walk instead of to a movie.”
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How much should I contribute to my RRSP?
It all depends.
“The amount that each of us can contribute is a function of both our income in prior years and any unused contribution room we’ve accumulated,” explains Chartered Accountant Alexandra Spinner, Senior Tax Manager at Soberman LLP in Toronto.
“In 2011, that amount — which can be contributed to either our personal or spousal RRSP — is generally equal to 18 per cent of 2010 earned income to a maximum of $22,450, less our 2010 pension adjustment (if any), plus any room carried forward.” Your 2010 Notice of Assessment from the Canada Revenue Agency will give you the exact figure, as will the My Account or the Quick Access tools on the CRA website.
To arrive at your “earned income” amount for the year, the CRA adds your employment earnings, self-employment earnings and certain other types of income (such as royalties, research grants or rental income) and then subtracts specific employment expenses and business or rental losses.
Strictly from a tax-deferral standpoint, Spinner says it’s usually advisable to contribute the maximum to your RRSP each year, if you can. She points out that if you don’t need the tax deduction now, you can still make the contribution and defer the deduction to sometime in the future when you do need it. In the meanwhile, you will still benefit from the tax-free growth in the plan.
But know when to call it quits. “For some people who perhaps don’t earn a lot, an RRSP deduction may not result in a significant tax saving,” says Spinner. “And post-retirement, if the withdrawal amount is significant enough, you could lose your income-tested benefits.”
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When should I start saving for retirement?
To paraphrase an old saying: If you have to ask, you probably should have started already.
“The earlier you start, the earlier your money can start compounding and the longer you’ll have it working for you,” says Chartered Accountant Gregory Clarke, Partner with SB Partners LLP in Burlington. “Contributions to an RRSP result in a tax deduction which is a key benefit that people attribute with Registered Retirement Savings Plans. In addition, income earned within the RRSP is tax-free but it is taxed when you withdraw it at a later date.”
To start a Registered Retirement Savings Plan, you must have a social insurance number (SIN) and “earned income”. The amount of your previous year’s income is used to determine your contribution room for the next tax year. For 2011, each taxpayer’s annual contribution room is calculated as 18 per cent of their 2010 earned income, to a maximum of $22,450, less any required pension adjustments. Also, any unused contribution room from previous years is carried forward so the amount that you can contribute may be higher.
“The best reason to start an RRSP early is that it gets young people into the habit of saving,” explains Clarke. “Even if it’s a couple hundred dollars a year, it helps create a mindset that saving is important.” For those looking to make their RRSP contributions to get a deduction on their 2011 personal tax return, you will need to make your contribution by February 29, 2012.
When an idea like that gets transformed into steady, continuous action, a secure financial future can’t be far behind.
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What size RRSP do I need to retire?
Determining how much you need to retire can be baffling. Where do you start?
“Assess your financial situation and personal needs,” advises Chartered Accountant David Trahair, author of Enough Bull: How to Retire Well Without the Stock Market, Mutual Funds or Even an Investment Advisor.
“The general rule is that you need 70 per cent of your pre-retirement income, but each situation is different. Figure out your expected retirement income and expenses. Do you own your own home, or will you have rental or mortgage payments? Do you have other outstanding debt or financial responsibilities, such as supporting an aging parent?
“Also consider your RRSP investments. Do you know what your annualized Personal Rate of Return (PRR) has been since you opened your RRSP? Many brokerage firms don’t provide this information on their monthly statements,” advises Trahair.
“Get rid of any debt at a higher interest rate. For example, if your PRR has been two per cent a year on average since you started your RRSP and your mortgage is at six per cent, then simple analysis shows that paying off the mortgage leaves you further ahead.
“Remember that your RRSP is supplemented by the Canada Pension Plan (CPP) and Old Age Security (OAS). If your RRSP is projected to provide enough income during retirement, you may want to optimize its size so it doesn’t spit out too much income and cause a clawback of Old Age Security.
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RRSPs and your benefits package
As you begin your new job, retirement may be the last thing on your mind. However, it can be beneficial to negotiate an RRSP contribution as part of your new remuneration package.
“Even if your new employer does not offer an RRSP matching program, having your employer direct your RRSP contribution to your financial institution will help your cash flow,” advises Chartered Accountant Jim Lockhart, Tax Partner, BDO Canada LLP in Kenora.
“This is because contributions made directly by the employer are not subject to income tax withholding. Let’s assume that you intend to make an RRSP contribution of $5,000. Because your employer is obligated to remit source deductions on your earnings, if you are in the top tax bracket you would have to earn approximately $9,330 in order to have $5,000 left to make the RRSP contribution.”
By having your employer make the contribution directly, your cash flow is increased as you are, in effect, receiving the tax savings up front. This extra cash flow could be used to further increase your RRSP contributions.
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The real costs of RRSPs
Registered Retirement Savings Plans are a terrific way to save for retirement and defer taxes. But choose your investment vehicles carefully. Many institutions charge substantial fees to both set up and operate those vehicles.
“The costs to administer RRSPs or other investment plans vary widely, depending on the nature of the plan and the level of service you receive,” says Chartered Accountant François Ménard, an Investment Advisor and Vice President with RBC Dominion Securities in Ottawa.
Some of the least expensive options are managed mutual fund portfolios. These plans are usually set up with a licensed representative who invests your money in a number of different mutual funds held in your RRSP account. Your representative provides some monitoring and advice, and in return takes a small percentage — usually around 1.5 per cent — of your total investment as a fee.
But check carefully and ask questions. Sometimes, these plans also include commission charged at the purchase or sale of the funds, and/or fees to transfer-in, transfer-out, and administer the fund.
At the higher end, professional fees can be about 2.5 per cent of the total value of your account, with an annual administration fee of perhaps $150, and transaction costs of two per cent or more for any trades that you make.
But there are lower-cost options, too. “There’s a lot you can do yourself,” advises Ménard. “Plenty of information exists for self-managing your RRSPs and investments.”
Many Canadian banks, insurance companies and other financial institutions have help available on their websites. Independent sources like Canadian Diversified Investor (www.canadiandiversifiedinvestor.com) and Efficient Market Canada (http://www.efficientmarket.ca) also offer a broad range of tools, tips and advice concerning RRSPs, investments, plans and costs.
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How long can I contribute to an RRSP?
“You can contribute to an RRSP up to and including the year you turn 71,” says Chartered Accountant Carmelo Linardi, of Carmelo Linardi Professional Corporation in Aurora.
However, you must have enough contribution room, generated from employment, self-employment and other eligible sources of income earned in the year prior to the year you will make the contribution. At the end of the year you turn 71, the RRSP must be converted into a Registered Retirement Income Fund or an annuity.
“Remember, even if your age prevents you from contributing to your own RRSP, you can still contribute to a spousal RRSP, as long as you continue to generate RRSP contribution room and your spouse is 71 or under (at the end of the year) in the year you make the contribution,” advises Linardi.
If you make a spousal contribution, your spouse can still make a contribution too, as long as he or she has his/her own contribution room. You get to deduct the amount that you contribute to a spousal RRSP from your income, while your spouse gets to deduct the amount of their RRSP contribution from their income.
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The strategy behind a spousal RRSP
Are you the highest wage earner in your family? Do you expect to generate the bulk of your family’s retirement income? If so, then a spousal RRSP can be an excellent strategy as it helps provide more equal retirement income and tax savings, according to Loren Francis, Chartered Accountant & VP, Private Client Group, of Barometer Capital Management in Toronto.
“Even though the new pension-splitting rules may allow a split of income from a single RRSP, a spousal RRSP can be beneficial when there is an age gap between spouses, and/or for estate-planning purposes.
“Different tax rates apply to couples versus individuals. The result is that a couple receiving two smaller incomes at retirement will be taxed at a lower rate than one individual claiming the total household income. When you contribute to a spousal RRSP, you will also get an immediate tax deduction – just remember that the contributions are owned and controlled by your spouse.
“If you are a married couple or living in a common law relationship, and have earned income or unused RRSP deduction room, you can also contribute to a spousal RRSP until December 31 of the year that your spouse or partner turns 71,” Francis advises.
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RRSP loans — don’t borrow what you can’t repay
The money we invest in our RRSP is supposed to help supplement our income in retirement. But for many in their prime earning years, the tax deferrals those RRSP contributions bring are just as important. Do those tax savings justify borrowing money to put into an RRSP?
“Under certain circumstances, borrowing for an RRSP can make sense,” says Chartered Accountant Hazen Henderson in Whitby. “In a year when your income is unusually high, the loan will enable you to contribute to your plan and receive a greater tax refund due to higher tax rates on your income in that year.” But interest on the loan is not tax-deductible, and you could end up repaying more to the bank than you actually make on the RRSP investment.
“For some, it’s a ‘forced-savings strategy’,” Henderson says. “They can’t seem to save the money, but they accept having to repay the loan.”
The best outcome, he says, is when the tax refund is used to pay down a significant portion of the loan. “But far better is to set up an automatic deduction that moves the money from your bank account straight into your RRSP each week or month, before you have time to spend it.”
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Mortgage payments vs. saving for retirement
Should you focus on paying down your mortgage or contributing to an RRSP?
“Mathematically, you can calculate which alternative is better, given assumptions about mortgage rates and the rate of return in your RRSP. Most analysts conclude that it is better to pay off your mortgage first, assuming that the rate of return of the investment in your RRSP does not exceed your mortgage rate,” says Chartered Accountant Ann M. Donohue, a Partner with Campbell Lawless Professional Corporation in Toronto.
“There are many factors that you should also consider. Will you be able to catch up on your RRSP contributions once you’ve paid off your mortgage? Will you need the funds in your RRSP for emergencies? Do you want to diversify your investments rather than place all of your available cash in your home?
“Keep in mind that having the discipline to save money, either by paying down your mortgage or putting money in your RRSP, will mean that you will increase your net worth in the long run. Both paying off your mortgage and saving for retirement are important components of any good financial plan,” advises Donohue.
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RRSP can help relatives with disabilities
Chartered Accountant John Mott in Toronto states that, “Amounts from the RRSP of a deceased taxpayer may be rolled over on a tax free basis to the Registered Disability Savings Plan (RDSP) of a child or grandchild who is financially dependent on the taxpayer due to mental or physical infirmity.”
The amount rolled cannot exceed the beneficiary’s RDSP contribution room, which currently has a lifetime maximum of $200,000. Rolled amounts won’t be eligible for Canada Disability Savings Grants, and will be taxable in the beneficiary’s hands when withdrawn, just like RRSP funds.
Taxpayers wishing to take advantage of these provisions should review their wills and make the appropriate amendments, if needed.
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Sometimes, it just doesn’t pay you to work
If you’ve been conscientious about investing in RRSPs, there can be a point at which it doesn’t make sense to keep drawing a paycheque.
“RRSPs should do more than simply allow us to defer taxes,” says David Aiken, a Chartered Accountant in Toronto . “The idea is to make the contributions when your marginal tax rate is higher than it will be when you withdraw them. As well, an adequately funded and properly managed RRSP will allow retirees to continue on with a secure, carefree lifestyle.
“By age 71, all your RRSPs must be converted to a Registered Retirement Income Fund (RRIF),” Aiken continues. “Those funds must then be withdrawn gradually as taxable income. The minimum amount required to be withdrawn increases with age. But if you’re still getting a salary, your RRIF income could be taxed at a rate that’s even higher than when you invested in the RRSP in the first place.”
“For example, while you’re actively working, your marginal tax rate may be as much as 46.4 per cent in Ontario. When you cash out your RRSPs at age 71 when you’re retired and your marginal tax rate is much lower, there’s a substantial saving,” Aiken explains. “An added bonus is that while your money is invested in the plan, neither the principal nor the earnings it generates are taxed.
“But if you’re still working full-time past age 65, you could continue to be taxed at that high marginal rate, or an even higher one. Then, your income may increase because you will begin collecting Old Age Security and may elect to receive Canada Pension benefits. Furthermore, if your income level is too high, Old Age Security benefits will be subject to clawback.
Factor in the expenses of working – the cost of commuting, clothes and lunches out – and that paycheque may not be providing as much added income as you hoped.
So if you’re blessed with the good health, joie-de-vivre and the desire to keep active after your 65th birthday, consider that golf, volunteer work and/or time with the grandchildren might be just as rewarding and not as hard as you thought on your bank account.
Check with a Chartered Accountant in your community to review your specific circumstances.
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Build RRSP room — file returns for the kids
Many kids earn income with part-time jobs and even babysitting. But because it’s usually below the basic exemption level, parents typically don’t bother filing tax returns for them to report it. While the amount of money involved may be small, the real loss is the RRSP contribution room that can never be made up.
Chartered Accountant Carmelo Linardi, of Carmelo Linardi Professional Corporation in Aurora, says this RRSP room could be significant, given the potential increased exemption thresholds and depending on the number of years the child’s income is below the threshold.
“Imagine a child who earns $5,000 per year doing summer work for a period of six years. That's not just $30,000 of tax-free income; it’s $5,400 of lost RRSP room. When that child becomes an adult wage earner and can make RRSP contributions to shelter tax at the top personal marginal rates, the savings could be as much as $2,500. That makes it well worth the trouble of preparing tax returns for six years.
“In addition, for children who reach the required age, certain credits — for example the GST/HST credit and Ontario Sales Tax credit, which will now be included as part of the new Ontario Trillium Benefit — are only available if a tax return is filed.”
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What belongs in an RRSP?
Say “Registered Retirement Savings Plan” and most of us think mutual funds, guaranteed investment certificates and savings accounts. Turns out, lots of other financial products and investments are RRSP-eligible, too.
“There are a variety of other investments that qualify,” says Chartered Accountant Alexandra Spinner, Senior Tax Manager at Soberman LLP in Toronto. “Qualified investments include shares of public corporations listed on prescribed exchanges in and out of Canada. Some bonds, mortgages – and, within limits, even shares of certain private corporations – are also eligible. There are many exceptions, however, so it’s important that anyone considering these kinds of investments consult with a competent, knowledgeable advisor.”
Remember that investments purchased inside your RRSP can lose value just as easily as they can outside the plan. Don’t take chances with your financial security. If you’re not sure what strategy is best for you and your situation, consult a Chartered Accountant in your community for advice about financial planning, taxes and RRSPs.
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Borrow to save for retirement
Is obtaining a loan to purchase an RRSP a good idea?
“An RRSP loan can be advantageous if you have accumulated a significant amount of unused RRSP room because it allows you to maximize your contribution,” says Chartered Accountant Tina A. Di Vito, Director of Retirement Strategies, BMO Financial Group in Toronto and author of 52 Ways to wreck your retirement and how to rescue it.
“For example, say you have unused room of $18,500 and your marginal tax rate is 46 per cent – if you can come up with $10,000 yourself and borrow $8,500, for a total contribution of $18,500, the RRSP contribution will generate a tax refund of $8,510 – just enough for you to pay off the entire loan.”
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The cost of withdrawal from your RRSP
If you withdraw money from your RRSP, here’s how it will affect you financially.
”If the withdrawal is $5,000 or less, you’ll be subject to tax of 10 per cent withheld at source; 20 per cent if the withdrawal is greater than $5,000 and less than or equal to $15,000; and 30 per cent for amounts greater than $15,000,” says Chartered Accountant Gary H. Kopstick, Partner, Taxation Group, Soberman LLP in Toronto.
He suggests that you consider several smaller withdrawals rather than one large lump-sum payment to reduce the tax withheld at the time of the withdrawal. “The reduction is only a tax deferral, as the withdrawn amounts must be reported on your tax return where they will be subject to your regular tax rate.”
Keep in mind that in situations where a taxpayer makes a single request to withdraw an amount in instalments, the withholding tax would be based on the total amount to be withdrawn.
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