Ah, tax time. For some it’s a burden, paying the government sucks. But at one point in our lives, we will be pulling a fast one and getting money back from the government. For some, this can come in the form of tax free investment option like a TFSA. You can learn how to buy stocks, start contributing to it and earn investment capital tax free. Your write-offs for having children, going to school, or starting a business can also be tax deductible. But for most, the money we receive every March will come from contributions to our RRSPs, or “Registered Retirement Savings Plans”.
So What Is The RRSP
An RRSP is simply a registered government investment account. Whenever you put money in, the government knows. Whenever you take money out (try not to do this early) the government knows. This started way back in 1957, in an account that was once called a RRA, or Registered Retirement Annuity. Since then it has become an extremely popular way for Canadians to invest.
Why? Well that’s the point of this article. If you don’t have an RRSP open yet, I’m sure after reading this you will be sprinting to your local bank. It’s an account that the large majority of Canadians are much better off having than not.
The Benefits Of An RRSP
An RRSP has many benefits. So much so that I’m not going to be able to explain every single one of them in this article. Instead, I’m going to go over some of the benefits that will apply to the large majority of Canadians. This way, I hit close to the bulls eye and help as many of you eager investors as possible. Lets start with quite possibly the most important benefit of an RRSP and why you are making a huge mistake not having one.
RRSPs Are Tax Deductible!
When you put money into an RRSP, the government has decided to allow you to deduct that off your income tax. What exactly does this mean? Well, it simply means any money you contributed to your RRSP is subtracted from your total income for the year. How does this benefit you? Say for example, and I am using very generic numbers here, you make $72,000 in a year. You fall into the 20.5% income tax bracket and must pay $14,760 to the government in income tax. Another benefit? Investments sold within a RRSP are not subject to capital gains like they would be in a non registered account.
However, lets say you were extremely frugal and managed to contribute the maximum to your RRSPS, which is 18% of your income, or in this case, $12,960. This contribution over the year is subtracted from your total income.
$72,000 – $12,960 = $59,040
The problem here is, we’ve now paid $14,760 in income taxes on $59,040 in total taxable income. Ever watch the “That’s Too Much!” game on the Price Is Right? You should be shouting it right now. Theoretically if we were to stay in the same tax bracket, you should be paying only $12,103 on your income. Subtract the difference, and you have the total amount you’ve overpaid, and the amount you will receive back from the government.
Now, like I said, the numbers get a little bit more complicated than this as you have different incomes taxable in different brackets. There are a lot of different provincial tax rates, which is why I chose to show you a bare bones federal tax rate just to give you the foundation of what exactly it means.
I thought I would explain this in the simplest form possible as I see a lot of people who are generally confused as to what the term “tax deductible” means. Also, if you’ve worked enough or worked multiple jobs you have probably overpaid your CPP and EI to the point where you will receive some of that back. But that is an entirely separate entity.
The First Time Homebuyer and Lifelong Learning Plan
I’ve explained the First Time Homebuyer program in a previous article, so I’m not going to beat that one to death. I’m more so going to go over the Lifelong Learning Plan and how you can use it to your advantage.
The government realizes going to school costs a lot of money. They also realize that some people, due to other expenses may not have the ability to just up and quit their job to pursue another career. The Lifelong Learning Plan allows you to pull money out from your RRSP to pay for full time schooling. One of the best parts about this program is it can be used on either you, or your spouse. If you’re not happy with your career, it’s possible you could utilize one of the most underrated programs in Canada if you currently have an RRSP with a balance.
I’m not going to go over absolutely everything about the LLP, because there is a lot. If you’d like to learn more, simply visit the Government Of Canadas page.
Contributing At A High Income, And Withdrawing At A Low Has Massive Advantages
This benefit is kind of the completion of the one-two punch in terms of tax deductions, but only applies to certain people. In our example above, the person making $72,000 is receiving 20.5% of their RRSP contributions back. Now, assuming they won’t be living like a complete baller in retirement, you can assume their post retirement income will not exceed $45,916, which is a 15% tax bracket. Often with no mortgage, the kids all moved out and the vehicle paid off, you generally don’t need very much to live off of.
When this person finally decides to withdraw their RRSPs, they will only be paying 15% income tax on the money they pull, as long as they stay below that income. I assume you can see where I am getting at. You receive 20.5% back, yet you only pay 15% when you withdraw.
Now, as I mentioned above this benefit doesn’t apply to all people. If you currently make an income that is taxable in the lowest tax bracket, the biggest benefit of the RRSP doesn’t really apply to you. You are receiving the same amount back in your working years as you are paying taxes in your withdrawal years. In this situation, it may be more beneficial for you to open a TFSA and start contributing to that. Your RRSP contribution room isn’t going anywhere, in fact it gets carried over every year. So it will still be there when you start to make a higher income, and these benefits will apply to you when you start contributing.
It Actively Makes You Save For Retirement
This benefit will draw the article to a conclusion, and I feel it is one of the most under stated aspects of an RRSP. When you open an RRSP and set up regular payments towards it, whether it be manually in your bank, or from a company RRSP, it puts saving for retirement in the background on autopilot. Sure, you can set up a savings account with your local bank and place $100 a week into it, but that money is easily accessible. We as humans gravitate towards temptations. When that balance hits $1500, you may be tempted to go out and purchase that new flat screen you’ve been wanting.
With RRSPs, there is taxable penalties when pulling the money out. It really makes you think about if you really need that money or not. Often, you are issued a 10% withholding tax right off the bat that the government takes from you. Then, in March you will be given a dreaded tax slip that returns you all the way to the start of this article, owing the government. You don’t want this. The government already takes enough of your money, don’t let them take any more.
Finally, if you’ve got a company matching plan, get on it immediately. At my current job, we had our RRSP matching taken away from us, and it was a huge issue for me. I like free money, and a company matching 2%, 4%, even 5% of your total income adds up substantially over the years.
I hope you guys liked this piece, and I hope if you don’t already have an RRSP you’ll consider opening one up today. When did you open your first RRSP? What’s the biggest cheque you’ve got back from the government? Let me know in the comments below. I love to hear feedback.