Tax season always brings up questions about one popular savings vehicle: the Registered Retirement Savings Plan (RRSP).
And it’s no wonder. The RRSP is one of the most useful and most complex savings vehicles available to Canadians. Not only is it a powerful tool for building your retirement nest egg, but you can also use it to go back to school, put a down payment on a home, and lower your income taxes this year!
RRSP stands for Registered Retirement Savings Plan, and it is a tax-advantaged account available to Canadians to help them save for retirement. RRSPs are always a popular topic at tax time because they can drastically affect your income tax return in a very positive way.
How the RRSP works to lower your taxes
You can contribute up to 18% of your gross income to an RRSP each year. In years where you do not use all your contribution room, you can carry unused contribution room forward to future years.
When you make contributions to your RRSP now and claim them on your income tax return, you will pay less in income taxes. This usually manifests as an income tax refund, which can be a huge boost to your budget!
In your RRSP, your money grows tax-free until you make a withdrawal. The Government of Canada recognize RRSP contributions come from pre-tax dollars, so they don’t hit you with a tax bill until you make a withdrawal. Because most people have a lower income in retirement than they do int heir working lifetime, the RRSP is a great tool to defer, and ultimately reduce, the total income taxes you pay over your life.
How much will the RRSP reduce my taxes?
How much the RRSP will reduce your taxes depends on what income tax bracket you’re in and how much you contribute to your RRSP. The higher your income and the more money you put away in an RRSP, the lower your income taxes will be.
You can expect to get 20% to 50% of your RRSP contributions back as an income tax refund. So if you put $1,000 in an RRSP, you’ll get an income tax refund of $200 to $500 because of those contributions.
Where should I open an RRSP?
Where you should open a Registered Retirement Savings Plan depends on how you want to manage the money. The most important thing is that you invest in the stock market! Y
ou definitely don’t want to leave your retirement funds in a savings account earning 1% or 2% interest, so you’ll want to choose a robo-advisor or self-directed brokerage account instead.
Opening an RRSP with Wealthsimple
Wealthsimple is a robo-advisor that provides completely hands-off investing in the stock market. All you need to do is open an account, add some funds, and they’ll take care of the rest! This is the best option for people who don’t know how or don’t want to manage their own investment portfolio.
You only need as little as $100 to open an account with Wealthsimple, but you can contribute more if you have it!
Once you open a Registered Retirement Savings Plan with Wealthsimple, you’ll be able to make a lump-sum contribution and set up an automatic transfer. Your money will be immediately invested in the stock market on your behalf, so you only have to sit back and watch it grow!
You can get your first $10,000 managed for free by signing up here.
Check out our full Wealthsimple Review here.
Opening an RRSP with Questrade
If you feel comfortable managing your own investments, you can open a self-directed brokerage account. To do this, you’ll need a minimum of $1,000 and a solid knowledge about selecting stocks and managing a portfolio.
The best features of Questrade are low trading commissions. Buying and selling stocks on Questrade is only about $5 or $6 depending on the trade and ETFs are free to buy! If you’re a new trader or just an average person that’s not moving tens of thousands of dollars around each trade, keeping your fees low is super important.
Check out our full Questrade Review here!
Using your RRSP contributions to maximize your tax refund
If you’re curious about how much of an income tax refund you can get based on your RRSP contributions, you can typically find out when you file your taxes. Most online tax software programs have a calculator that will let you test how extra RRSP contributions can impact your return.
RRSP contributions lower your taxable income
Let’s say you earned $60,000 in 2019 and contributed $2,000 to a Registered Retirement Savings Plan. If you record and claim those RRSP contributions on your taxes this year, your taxable income will be $60,000 – $2,000 = $58,000.
Because you paid income taxes on an income of $60,000 but now your actual income is $58,000, the government will give you an income tax refund for the taxes paid on that $2,000. If you live in Ontario, this will result in an income tax refund of approximately $584!
A $584 refund on a $2,000 RRSP contribution represents a 29% instant return on your investment.
RRSP contributions increase the Canada Child Benefit (CCB) you qualify for
If you are a parent that receives the Canada Child Benefit (CCB), contributing to your RRSP can increase the amount you receive! Because the CCB is calculated based on your taxable income, lowering this amount with RRSP contributions will increase the amount you qualify for.
For example, if you earn $50,000 per year and your spouse earns $60,000 per year in Alberta, your total household income is $110,000. At this income, you’ll receive $2,853 per year in CCB or about $237 per month. If you contribute $10,000 to your RRSPs, it will lower your household income to $100,000. You’ll now receive $3,173 per year in CCB or about $264 per month. You’ll also get approximately $3,600 back as an income tax refund!
In other words, making $10,000 in RRSP contributions only cost you $6,000 out of pocket after your income tax refund and extra Canada Child Benefit. The more RRSP contributions you make, the greater your income tax refund and the more CCB you qualify for!
The RRSP is better at lowering your taxes if you have a high income
Because the RRSP favors higher incomes, it makes the most sense to choose the Tax-Free Savings Account (TFSA) over the RRSP until your gross income is greater than $50,000. If you have children you claim as dependents or have other tax-deductible expenses, you may even want to wait until your income is greater than $70,000 to begin contributing to an RRSP.
When should you claim your RRSP contributions?
One of the great things about contributions to the Registered Retirement Savings Plan is you don’t actually have to claim them the year you make them. This means you can put $5,000 in your RRSP right now, but not claim the contribution until 2021 or 2025 or another year in the future!
Why would you want to make RRSP contributions but not claim them? The answer is simple: because you have the money to contribute right now, but you can get a greater tax benefit in the future when your income is higher.
The best part? Your contributions grow tax-deferred inside the RRSP while they wait to be claimed in a future tax year!
The RRSP deadline for 2020
You have until March 2, 2020 to make RRSP contributions for 2020.
This means you can top up your RRSP in the first few months of 2020 and have it count towards last year’s contributions in order to fully leverage the tax-saving opportunity of the RRSP. Want a fatter income tax refund? Open an RRSP account with Wealthsimple or Questrade right now and make your contributions so you can claim them when you file your taxes!
Start saving now
Many Canadians are intimidated by the many options when to contribute, and when to claim your contributions, to an RRSP. But the flexibility of this savings vehicle can help reduce the income taxes you pay which will give you even more money to save!
If you haven’t yet, open an RRSP and start making contributions to give you a tax break for last year, this year, or in the future!