This post was sponsored by Sun Life Financial. For more information and to access their suite of RRSP tools, please visit www.sunlife.ca
Looking forward to retirement? You should!
Research shows that retirement is good for you. Multiple studies have shown that retirees live a more active lifestyle and get a healthier amount of sleep than adults in the workforce.
Retirement can be a very exciting time. Gone are the rules. No deadlines. No need to set an alarm. You’ll have more opportunity to focus on your personal interests. You may want to volunteer, travel, fish – oh, the possibilities!
But if you want to enjoy retirement, you need a plan. Not just a to-do plan, but a solid financial plan.
No matter if you are 20 or 50 years old, it’s never too early or too late to plan your financial retirement goals.
At the base of any good retirement plan is a registered retirement savings plan (RRSP). The bread and butter of Canada’s retirement system, the RRSP is an important savings vehicle.
What is an RRSP?
An RRSP is not a stock, bond or mutual fund. It’s not some type of investment product. An RRSP is simply a type of account. Think of it as a glorified savings account that enables you to grow your money tax-free until it’s withdrawn.
There are two main benefits to contributing to an RRSP:
1. Contributions are tax deductible
“Tax-deductible contributions mean you’ll have more of your income available for your current needs, even while you’re saving for the future.” – Sun Life Financial
Why? For every dollar you contribute to an RRSP up to the allowable limit, your taxable income is equally reduced. Hence, you pay less taxes.
Less tax equals more money in your pocket. For example, assume you have $50,000 in annual income and a 36% tax rate. Let’s also assume you contributed $5,000 to your RRSP throughout the year. Come tax time, you will save $1,800 in taxes ($5,000 x 0.36).
2. Taxes on investment growth are deferred
“An RRSP is a powerful savings vehicle because the taxes on any investment growth are deferred until you take your money out.” – Sun Life Financial
This applies to any capital gains, dividends or interest gained from your investments. It grows tax-free until withdrawn.
Although the content of this article focuses on individual RRSPs, there are two other types of RRSPs: spousal RRSPs and group RRSPs. Learn more about the different types of RRSPs.
How to open an RRSP
Over the years, opening an RRSP account has become very simple. You can open an RRSP through most Canadian financial institutions. Banks, credit unions, insurance companies, brokerage firms and robo-advisors all have RRSPs.
You can open an account online or through your financial institution. All you need is two government-issued pieces of identification. And contrary to popular belief, you do not have to be 18 to open an RRSP. If you are working and earning income, you can open an RRSP.
Before selecting a financial institution, do your research. Each will have its own fee structure and types of plans. It’s important to understand what you are paying for and what types of investments you can hold in your RRSP. They are not all the same.
What types of investments are eligible?
You can hold a wide variety of financial products in your RRSP account. Bonds or Bond ETFs, GICs, mutual funds, segregated funds, exchange-traded funds (ETFs) and stocks, to name a few.
What type of investor are you? How much risk can you tolerate? You need to know the answer to these very important questions. If you are new to investing, it’s highly recommended you reach out to an advisor.
“An advisor understands how RRSPs work and can show you how to structure your contributions and choose your investments to make the most of the benefits offered by this powerful savings vehicle.” – Sun Life Financial
The advantage of holding U.S. dividend stocks in an RRSP
If you have U.S. dividend stocks, there’s an advantage to holding them in an RRSP. Why? Canada and the U.S. have a bilateral treaty that exempts retirement accounts from the dividend withholding tax.
Many investors incorrectly assume that the tax-free savings account (TFSA) is also exempt. It’s not. If you hold U.S. dividend paying stocks in a TFSA or other non-registered account, they are subject to a 15% withholding tax.
What is the RRSP contribution limit?
Every year, the Canada Revenue Agency (CRA) sends you a document called a “Notice of Assessment” after it processes your taxes. The document includes your RRSP contribution limit, which is rolled over year after year. In other words, if you’ve been working and paying taxes and not contributing to your RRSP, your contribution room continues to add up.
“Generally speaking, you are allowed to contribute up to 18% of your previous year’s earned income to the maximum amount set each year by the Income Tax Act and Regulation — $26,230 for 2018 –, plus any unused contribution room carried forward from prior years.” – Sun Life Financial
You can contribute as little or as often as you like, so long as you stay under your contribution limit.
When is the contribution deadline?
“The deadline for making a contribution that will affect your tax bill any given year is 60 days after the end of that year.” – Sun Life Financial
For example, any contributions you made during the first 60 days of 2018 (up until March 1) were eligible to be claimed against your 2017 taxes.
A well-balanced RRSP strategy should include regular contributions. The earlier you contribute, the more your growth will compound.
Penalty for excess contributions
It’s very important to stay below your contribution limit. The CRA allows investors to over-contribute by $2,000 but that amount cannot be used to claim a tax deduction. If you go over the $2,000 threshold, it can be costly. Typically, you have to pay a tax of 1% per month on any excess contributions. That can add up quickly.
If you accidentally over-contribute, you can ask the CRA to waive the additional tax. You have to prove that the contributions were “due to a reasonable error” or that you are taking steps “to withdraw the excess contributions.”
How much income do you need in retirement?
Quite literally, how much you need for retirement can be a million-dollar question. How much should you be putting away? How much is too much? These are all important questions to ask. The best way to answer them is to talk to an advisor.
How much you need depends on your desired retirement lifestyle. Everyone’s needs will be different. There’s no agreed-upon consensus. Some advisors estimate that you need about 70-80% of your peak annual pre-retirement income. Others recommend 50-60%.
There are a myriad of factors to consider. Is your mortgage paid off? Are your kids financially dependent? Do you intend on doing significant travelling? Does longevity run in your family? Do you want to be prepared for long-term care costs?
When planning, it’s always better to over-estimate your needs rather than come up short.
How much do you need to save?
Have an annual retirement income in mind? A quick and easy way to determine how much you need in savings at the time of retirement is to use the 4% rule. The principle of the rule is that if you can get a 4% return (after fees) on the investments in your retirement savings, you can safely withdraw 4% a year from your retirement portfolio without touching your capital. Let’s assume you are targeting $40,000 in annual retirement income on top of what you expect to receive from CPP, OAS and your defined-benefit company pension. Using the 4% rule, you will need $1 million ($40,000/0.04) in savings to reach your goal. A few things to note, however:
- The rule doesn’t apply if your investment returns fall short of 4%.
- You also have to factor in income tax on whatever you withdraw.
- If you’re using a registered retirement income fund (RRIF) to turn your RRSP into income, you will be required to withdraw an increasing amount from it each year – nearly 7% by age 80, and more as you get older.
An easy way to check if you are saving enough is to use a free, online RRSP calculator. It’s simple, easy to use and you get your results within minutes. You can also play around with the numbers to see how different savings, contributions and rates of return can affect your savings.
Sun Life’s calculator also takes into account early withdrawals. You never know when life will throw you a curveball. It happens. Knowing how an early withdrawal will affect your retirement goals is a critical component of your retirement plan. Don’t get caught off guard!
Set yourself up for success
Knowledge is power. The more you leverage an RRSP account, the better off you will be in retirement. It’s a powerful investment tool.
Saving for retirement may at first seem daunting, but a solid financial plan can make or break your retirement. An advisor can help you build a plan tailored to your specific needs.
Get started as early as you can. Your future self will thank you for it.
This post was sponsored by Sun Life Financial.