Understanding RRSP Contributions

Understanding RRSP contributions is a key aspect of retirement planning in Canada. The Registered Retirement Savings Plan (RRSP) has been a popular option since its introduction in 1957. One of the biggest advantages of RRSPs is the tax-deferral feature, which can greatly enhance retirement savings. However, it is important to remember that RRSP contributions are not tax-free and will be fully taxable when withdrawn during retirement.

The tax-deferral feature allows for contributions to be made during higher-income earning years when tax rates are higher, and the funds can be accessed during retirement when tax rates are lower. Additionally, meeting certain conditions and having sufficient contributions in an RRSP account can also provide access to other benefits such as the Home Buyers’ Plan (HBP) or Lifelong Learning Plan (LLP).

In order to make the most of RRSPs and properly plan for retirement, it is important to understand the various aspects of RRSP contributions, deductions, over contributions, and more. By gaining a deeper understanding of these concepts, individuals can create solid wealth management plans and ensure a secure retirement.

Motivating Canadians to put away money for retirement, RRSP contributions are a great choice for reducing taxable income and paying less tax now, while potentially building a larger retirement fund. Basically, every year until you reach 71 years of age, you can contribute a certain amount to your tax-advantaged RRSP account and pay tax on this sum only when you withdraw from your fund in the future. It is also possible to contribute to your spouse’s RRSPs.

However, there is an upper limit on the RRSP contribution room that you can build each year. Your total contribution room** for the year is the lower of

• 18% of your earned income for the previous year
• The maximum yearly set limit (defined by the CRA). The maximum RRSP contribution limit in 2021 was $27,830*, while the 2022 limit is set at 29,210*. This amount may change every year and has been steadily increasing over the years.

* The deduction limit is the maximum allowable contribution for that year and does not take into account any unused contributions from previous years.

** If you are a member of a pension plan, your RRSP contribution room will be reduced by the amount of your pension adjustment.

Let’s say you made $100,000 in the previous year and decided to put the maximum allowable amount ($18,000) in your RRSP account. During the annual tax calculation, your taxable income for that year will be $100,000 minus 18,000 i.e., $82,000, saving you the tax on your RRSP contribution amount. At a future date, any withdrawal from your RRSP account will count as fully taxable income, but by then, you will most likely fall under a lower tax bracket due to age and income.

It is important to note that any amount you do not contribute in a certain year carries forward indefinitely. Hence, even if you did not utilize your contribution room in one year, you can add that amount to your RRSP contributions anytime during the following years. You may still have to be mindful of your deduction limit for the year (explained further in the next section).

For example, let’s assume your 2020 annual income was $90,000, which allows you to make an RRSP contribution of $16,200 for that year, but you contributed only $15,000 due to other financial priorities. In the following year, your 2021 income is $100,000, which allows you to make RRSP contributions of $18,000. At this point, you can add the leftover contribution from the previous year (i.e., $16,200 – $15,000 = $1,200) to the current year. That way, your contribution for the current year will be $18,000 + $1,200 = $ 19,200, which is still within the maximum set limit of $27,830.

RRSP contribution is the amount of money that you invest in your RRSP account in a given year. An RRSP deduction is how much of that contribution you have used in your tax return to reduce your taxable income reported on the T1 Income Tax and Benefit Return (“T1”). Typically, RRSP contribution and RRSP deduction would be the same amount if you have fully deducted all your past RRSP contributions. The only time these amounts differ is if you have deferred your deduction from a past year to a future tax year. In such cases, you may add any unutilized amount from your past contribution room to another year’s RRSP contribution.

Essentially, the RRSP deduction limit takes into account the amount of contribution you have deferred to use for future tax returns. Hence,

RRSP Deduction Limit = Unused deduction room of preceding years + Available contribution room for the current year

If you are part of a pension plan through your employer, there will be a Pension Adjustment (PA), Pension Adjustment Reversal (PAR), as well as Net Past Service Pension Adjustment (PSPA). In this case,

RRSP Deduction Limit = Unused deduction room of preceding years + Available contribution room for current year + PA or prescribed amount (whichever is higher) + PAR – PSPA.

When you review your Notice of Assessment by the CRA, you will get an at-a-glance summary of your Tax-Free Savings Account (TFSA), as well as your RRSPs. This calculation is based on the deduction limit set by CRA, as well as your own past contributions and contribution room utilization.

Your RRSP contribution room grows by 18% of your previous year’s earned income or up to a maximum set limit, whichever is lower. If you participate in a workplace pension plan, there will be a pension adjustment ((provided by your employer), which reduces your RRSP contribution room up to that extent each year. However, you have the option to include an unutilized deduction room from previous years into your RRSP contributions for any given year, which may lead to a possibility of overcontribution to RRSPs. Any amount that exceeds the contribution limit given in your previous year’s Notice of Assessment constitutes overcontribution. Over your lifetime, you can over-contribute up to $2,000 without attracting any penalties. Any overcontribution that exceeds $2,000 is subject to a hefty tax of 1% per month on the ***excess amount until such time as you withdraw the excess amount, or gain adequate additional RRSP contribution room to accommodate the surplus. Additionally, you must report any instance of overcontribution to the CRA within 90 days after the last day of the tax year when you overcontributed. In case of delays, there is a penalty of 5% of the taxes you owe, which is in addition to the 1% per month that you will pay.

Here’s a look at an instance of overcontribution:

Let’s assume that the Notice of Assessment states your RRSP deduction limit for 2020 is $20,500, and you contributed $14,000 to your own and your spouse’s RRSPs in that year. In the following year 2021, your annual income was $125,000, and you had no other PA adjustments from previous years. Which means, your deduction limit for 2021 will be 18% of $125,000, i.e., 22,500, while your contribution room for that year will be 29,000 [$22,500 + ($20,500-$14,000)]. If you decide to utilize the previous year’s deduction room as well as the current contribution room, you will invest 29,000 in your RRSP account, which means you have overcontributed by $1,170 since the CRA-set deduction limit for 2021 was 27,830. However, since this is still under $2,000, you are exempt from any penal taxes, assuming there are no other instances of past overcontributions in excess of $2,000.

*** Canadians under age 18 do not have the cushion of $2,000. Any amount in excess of the deduction limit is subject to the 1% tax per month.

What Canadians Should Know About RRSP Accounts and RRSP Contributions?

Here are some aspects related to opening and contributing to RRSPs:

• Canadians can open an RRSP account at any time. There is no ****minimum age. However, those under 18 may have to set up one with their parent or guardian.
• As long as you have employment income, you file a tax return, and you have contribution room, you can contribute to your RRSP account, or even to that of your spouse or common-law partner.
• The CRA tracks your contribution limit on your Notice of Assessment each year after you file your tax return. Hence for the subsequent year, you simply have to refer to the “Available Contribution Limit” calculated by CRA for you.
• The deadline for RRSP contributions is usually 60 days after the year end. Typically, it will be March 1 or February 29 (in case of a leap year), or the following Monday (if any of these dates fall on a weekend).
• You can contribute to your own RRSP until December 31 of the year you turn 71.
• When you turn 71 years old, you will have to withdraw the RRSPs, transfer them to a Registered Retirement Income Fund (RRIF), or use the funds to purchase an annuity.

So how much can Canadians contribute or deduct from their RRSPs? It depends on your individual RRSP deduction limit, which you will find on CRA’s Notice of Assessment.

The deadline to make an RRSP contribution is 60 days after year-end (March 1st, or February 29th in a leap year, or the following Monday, if March 1st or February 29th falls on a weekend.)

**** Certain financial institutions may require a customer to be over the age of 18 years to open an account.

Nour Private Wealth (NPW) offers specialized wealth advisory services to assist high-net-worth individuals and families in managing their wealth in a tax-efficient manner. Our team of experienced wealth advisors can help with asset management, estate planning, and investment planning, to ensure that you meet your financial goals. We serve clients across seven Canadian provinces and can provide guidance on Understanding RRSP contributions and maximizing deductions for a financially secure retirement. Contact us to learn more.