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I call the RRSP “a million-dollar money machine” because it’s the most tax-efficient retirement saving vehicle available to Canadians. Here are five key reasons why.
1. You can retire with a million bucks
An RRSP is such a powerful retirement savings vehicle that most average wage earners can use it to retire with a million dollars. That’s because an RRSP lets you contribute a maximum of 18% of your “earned income” every year (less various “adjustments” related to pensions) to a pre-set maximum. For 2020, the maximum contribution limit is set at $27,230 (climbing to $27,830 for 2021). And the last day to make a contribution for the 2020 tax year is March 1, 2021.
If your tax deduction results in a tax refund, reinvest the refund in your RRSP right away to keep that compound growth working for you. If you begin at age 40, and contribute, say, $20,000 per year for 25 years, at an average annual compounded 8% rate of return, you’ll retire with $1.7 million.
Your investments grow tax-free inside an RRSP. You don’t pay tax until you withdraw funds from your RRSP at retirement, and then you pay tax on the withdrawals at your full marginal rate. But that will typically be lower than during your peak earning years.
2. You can carry forward contribution room
If you are unable to make the maximum RRSP contribution in a given year, you can carry forward the missed contribution indefinitely as extra contribution room for future years. Your unused contribution limit is also shown on your CRA Notice of Assessment. The carry-forward feature may be especially useful for those who expect to be in a higher tax bracket in future years.
3. You can split income
One of the very best income-splitting strategies is the spousal RRSP. If you are married or living common-law, you can contribute to your spouse’s plan, and you get the tax deduction. However, your spouse gets the benefit of the tax-sheltered compounded growth in the RRSP. Your contribution to a spousal plan will not shrink your spouse’s contribution limit to his or her own plan. For greatest tax efficiency, the spouse with the higher income should contribute to the spousal plan. It’s a great way to get a tax break and keep it all in the family, too.
4. You can borrow to contribute
If you borrow funds to make an RRSP contribution, you’ll still get a tax deduction on the contribution, you may be able to pay down the loan with your refund, and your investment could well earn more than the interest on the loan. But there are a few downside risks to consider.
The downside is that if you invest in risky assets, like stocks, you could magnify any losses that may occur. In other words, the value of your investment may end up being less than the value of your loan. In addition, you cannot deduct interest on loans used for RRSP contributions.
5. You can buy a home
Looking for a source of funds as a down payment on your first home? If you have a good chunk of money sitting in your RRSP, you may be eligible to use some of it towards the purchase of a home under a federal government plan called the Home Buyer’s Plan (HPB.
Under the HPB, first-time home buyers who meet certain conditions can withdraw up to $25,000 from their RRSPs (provided the funds are there) in a calendar year to buy or build a qualifying home.). If you’re a young couple, it could mean as much as an extra $50,000 to tack on to a down payment. Even better, that amount will not be included in your income and tax will not be withheld on the withdrawal. you have to repay the HBP withdrawal back into your RRSP on a regular basis over a maximum of 15 years, so you’ll still be rebuilding your RRSP over time.
Robyn Thompson, CFP, CIM, FCSI, is the founder of Castlemark Wealth Management, a boutique financial advisory firm specializing in wealth management for high net worth individuals and families. Contact her directly by phone at 416-828-7159, or by email at rthompson@castlemarkwealth.com for a confidential planning consultation.
Notes and Disclaimer
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The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned are illustrative only and carry risk of loss. No guarantee of investment performance is made or implied. It is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. Please contact the author to discuss your particular circumstances.
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