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Tips and tricks for Canadian tax filers at every stage of life from UFile's tax expert Gerry Vittoratos



It's The Most Wonderful Time of the Tax Year

by UFile Team Équipe ImpôtExpert | Jan 22, 2019   Comments:

UFile Blog - RRSP

It’s that time of year again! No, not the holiday season in late December but the equivalent for taxes: RRSP season! Let’s have a look at the basics of this wonderful tax “holiday.”

What are RRSPs?

An RRSP, or Registered Retirement Savings Plan, is a vehicle created by the federal government to allow you to save and invest your hard-earned dollars in a tax-deferred account. Notice the term ”tax deferred” meaning that it is NOT tax free; any money entered into the plan is allowed to accumulate tax free until you are required to pull it out.

What can I buy within an RRSP?

Practically all investable assets such as money, guaranteed investment certificates, government and corporate bonds, mutual funds, and securities listed on a designated stock exchange. An RRSP is not an investment; it is simply a plan in which you BUY investments and defer the applicable tax.

Where can I buy investments for my RRSPs?

Banks, investment companies, insurance companies and stock brokers are some of the places you can visit to buy investments within your RRSP.

Is it really worth it?

The short answer is yes. Even if you don’t have a lot of income to spare, an RRSP is a great long-term savings vehicle. It allows you to defer taxation on any amount you have set aside until your retirement (which occurs at age 71 for the CRA; your RRSP then converts to a RRIF). This alone is a huge advantage compared to the same investments outside of an RRSP, where any income generated (interest, dividends, capital gains) is immediately taxed. This deferral allows you to accumulate a substantial nest egg by the time you’re required to pull out of the plan at age 71.

Is it really worth it? – Part 2

So your money grows in a tax-deferred way, but is there any other advantage to contributing to an RRSP? Now that’s where things get really interesting. Not only does your money grow without interference from the taxman until your required withdrawal, but you also get a tax deduction to boot! Any contributions you make to your RRSP during the year get deducted from your net income when determining your taxable income. This represents an instant return on your investment before your money has even had time to work for you. We will use a simple example to understand the mechanics.

John made $40,000 during the year. He has about $3,000 to invest and is thinking of putting the money into RRSPs. At $40,000, John falls into the 15% federal tax bracket. Let’s see what results John would get with and without an RRSP contribution:

Without RRSP:                 $40,000 x 15% = $6,000 tax payable*

With RRSP:                         $40,000 - $3,000 = $37,000 x 15% = $5,500 tax payable*

* For simplicity and to highlight the impact of the deduction, we have not considered the effect of non-refundable tax credits. Lowering net income would increase other credits, such as medical expenses. We have also not factored in provincial taxes.

From the example above, we see that John gets an extra $500 back from the CRA simply for contributing to an RRSP.

And just like in a TV infomercial, there’s more! Not only do you get the tax deferral and a reduction in taxes, you also get an increase in certain benefits and credits such as the GST credit, the Child Tax Benefit and the medical expense credit. Amounts such as the GST credit and the Child Tax Benefit are based on your net income, and since your RRSP contributions reduce your net income, you will be able to claim more of those. Credits that appear on your tax return, such as the medical expense credit, are also based on your net income; the lower your net income, the more you will be able to claim.

RRSP contributions really provide a big return on your investment. Few other plans can make that claim.

Can I put as much money as I want in the plan?

No, you are limited to the lesser of 18% percent of your earned* income, or the set maximum, which is indexed every year ($26,230 as of the 2018 tax year). This amount is what is called your RRSP limit. You can find out your limit by looking at your previous year’s Notice of Assessment, or by going to the My Account page on the CRA’s website. Any unused room accumulates to future years.

*To the CRA, earned income means employment income, net self-employment income, net rental income, taxable support payments, etc. So not all income is considered earned income by the CRA, especially interest income, dividends and capital gains.

Have more questions about making the most of your RRSP contributions? Connect with us on Facebook and Twitter for news and updates on the 2018 tax return and UFile online tax software. Visit Tax & U to get accurate answers to all your questions about your 2018 tax return.

 

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