These days, a Registered Retirement Savings Plan (RRSP) is considered an offensive four-letter word to some people. RRSP ads can be seen everywhere, as the annual contribution deadline rapidly approaches. But a recent H&R Block survey suggests that most Canadians under 65 do not make or maximize their contributions this year. The reasons are many: volatile stock markets, unstable employment conditions, and record household debt levels to name a few. In fact, it was only a month ago when Statistics Canada warned that credit-market debt (such as mortgages) increased to 162.6% of disposable income in the third quarter of 2014, up from 161.5% in the second quarter.
Another reason arises from the growing familiarity of the Tax-Free Savings Account (TFSA), which was introduced in 2009. In times of financial uncertainty — where cash is king — families may prefer the TFSA over the RRSP, as the TFSA offers the ability to make tax-free withdrawals. (Assuming the TFSA withdrawals are made properly.) In contrast, for RRSP withdrawals made before age 71, the entire amount withdrawn is added to your income and subject to tax, and your bank holds back a withholding tax on the amount withdrawn. Dipping into your RRSP is generally a bad idea for that reason.
Given these circumstances, it is unsurprising that some may decide not to max out their RRSP this year – particularly families with lower disposable income. It’s important to remember though, that in the long run, RRSPs are an important financial vehicle that promotes retirement savings. In the short term, there are immediate tax benefits, as the amount contributed can be deducted from gross income and reduce income taxes. In between, RRSPs allow for tax-deferred investing until the funds are ultimately withdrawn.
The RRSP remains a powerful retirement planning mechanism that stands the test of time – almost 60 years now. However, this is not to say that you should make RRSP contributions at all costs. Interest incurred on funds borrowed to make an RRSP contribution is not deductible for tax purposes, so borrowing to contribute is also a bad idea. Rather, it is better to contribute based on available cash, and borrow to fund other income-earning activities (where interest may be deductible).
Lastly, there are special rules for deceased persons. Generally, when a person dies, the fair market value of investments held in an RRSP at the time of death is fully included in the income of the deceased for the year of death – unless the RRSP is transferred to a spousal RRSP, or to one that benefits financially dependent children or grandchildren. But what happens when there is a decrease in value of the investments subsequent to death (and before distribution from the estate)? The CRA allows a deduction for this decrease in value, which can be carried back and deducted against the RRSP income inclusion in the year of death. However, a prescribed form must be timely filed in this regard.
In a world where being offended is trending and popular, it may be tempting to perceive the idea of making RRSP contributions offensive to your wallet – at least for the short term. But it should not be that offensive when those contributions increase your tax refund later in the year or increase your retirement savings later in life. Don’t miss the bigger picture!
- March 2, 2015 is the deadline for contributing to an RRSP for the 2014 tax year.
- $24,270 is the RRSP maximum annual contribution limit for the 2014 tax year.
- Your 2014 RRSP deduction limit is the lower of 18% of your 2013 earned income and $24,270, then minus any company sponsored pension plan contributions.
- Any income you earn in the RRSP is usually exempt from tax, as long as the funds remain in the plan.
- For seniors: December 31 of the year you turn 71 years of age is the last day you can make a contribution to your RRSP.
Charles Fu is the Senior Tax Manager at Sloan Partners. Contact Charles today for an analysis of your family’s tax savings opportunities.