Saving towards your retirement is like an investment in a comfortable future for yourself and your family. A retirement plan is vital in securing your financial future. There are several retirement plans available in Canada, but we will be covering the specifics of an RRSP in this blog.
What’s an RRSP, and How Does it Work?
A Registered Retirement Savings Plan (RRSP) is a popular retirement account used by Canadian individuals, especially due to the tax benefits this plan provides. Established by the Canadian government in 1957, RRSPs are tax-deferred until the contributor retires. This means that if you contribute to an RRSP, you will not pay tax on it until you need to withdraw from it, making it a great way to save on your annual tax bill. The Canada Revenue Agency (CRA) states that any income you earn in an RRSP is tax-free while the funds remain in the plan; you generally have to pay taxes if you receive payments from the plan.
What is the Difference Between an RRSP Contribution and Deduction?
An RRSP contribution refers to the amount you invest (pay) into your RRSP account. However, an RRSP deduction refers to the portion of your contribution that is deducted from your taxable income and reported on your T1 Income Tax and Benefit Return.
Canadians have the option to defer their deduction until a future tax year, which can be beneficial if their future taxable income is expected to be higher than it currently is. It will take advantage of the RRSPs tax-deferred growth but apply it to a higher tax year.
How Much Can You Contribute to and Deduct from Your RRSP in Canada?
RRSPs are registered accounts and are, therefore, governed by certain rules. An important rule pertains to the amount you can deposit into the account each year: the contribution limit. Your contribution limit refers to the amount you are able to deposit into your RRSP in a specific year.
Because contributions to an RRSP reduce the amount of income tax an individual must pay, the Canada Revenue Agency (CRA) establishes an annual limit on the number of contributions eligible taxpayers can make to an RRSP in order to prevent excess contributions. Instead of deducting unused contributions from years past, the deduction limit refers to this year’s limits.
The amount you can contribute to an RRSP each year is either 18% of your past-year income or a maximum amount, whichever is smaller. Amounts not contributed carry forward indefinitely. Additionally, if you didn’t max out your investments in earlier years, you can catch up by reviewing your Notice of Assessment from last year. Be mindful that even though you might have contribution room left over from previous years, you won’t accumulate deductions.
It is possible to have more than one RRSP account. In addition to “regular” RRSPs in your name, it is possible to contribute to a “spousal” RRSP, which is set up in your spouse’s name, and you receive the tax deduction for your contributions.
The CRA allows a $2,000 grace amount for over-contribution without charging a penalty. Contributions in excess of this limit are not eligible for RRSP deductions. Unless the over-contribution to an RRSP is immediately withdrawn or contributed to a qualifying group plan, there is a penalty tax of 1% per month for contributions over $2,000. The penalty tax should be paid within 90 days after year-end to prevent further late-filing penalties or interest charges.
Retirement savings are an investment in your financial future. If confusion and anxiety about minor details are holding you back from contributing to a retirement plan, Nour Private Wealth can help. At NPW, our specialty is meeting the needs of high-net-worth families, so you can rest assured you’re getting the best investment planning services available. Contact us today for more information or to find out more about what retirement plan suits your needs best.