Like about a third of Canadians I waited until the last minute to file. I hit submit on the Turbo Tax software package I use at about 3:00 pm on April 30th. Not literally the last minute but awfully close.
About two weeks later the government sends you your NOA (that’s financial advisor language for Notice of Assessment) which confirms what you submitted. It’s not the final word, you could still receive the dreaded audit notice but for now your taxes are officially filed, Yippee!
There is a neat little line item on everyone’s NOA, that I think most people know about but that still bears a bit of explanation. It’s your RRSP contribution limit.
As a financial advisor I get a lot of questions about RRSPs. A few years ago, I noticed that there seems to be a bit of a seasonal pattern to the questions I get. Most of the questions come in February as the annual contribution deadline looms but I also get a batch of questions in September, as the kiddies are heading back to school, and we are all waking up from our summer slumber, and right around now as people receive their NOA and see that little line item at the bottom of the page.
In case you are wondering here are some answers to the most frequently asked questions, in no particular order:
1.What is the contribution limit and how is it calculated?
There are lots of factors that go into calculating your contribution limit each year, but the simple math is 18% of your previous year’s income minus any contributions made to a pension, employer sponsored share-purchase plan or group RRSP.
Any unused contribution room from previous years is carried forward into the next year indefinitely or at least until you reach the mandatory dissolution age which I will explain in a minute.
There is also a maximum income that can be used towards the calculation, this past year if you made over $151,277 your contribution limit is capped from there on up at $27,230.
2. Where Should I Invest My RRSP?
A lot of people have opened an RRSP at their bank and yet have no idea how that money is invested. I’ll be honest, that drives me crazy.
Usually, it’s because they filled out a risk assessment questionnaire which told them if they were an aggressive or conservative investor and their banker told them which mutual funds fit that profile. Essentially, they did what their banker suggested without doing any further research.
The problem with that approach is at least twofold:
- Most people when asked will almost always err on the side of caution. The pain of loss, or even the anticipation of loss is always more acute and long lasting than the joy of gain. The questions asked when you open an investment account are designed to make you more conservative than you are so that the banks don’t get sued if your investments lose money. Nobody thinks about the long term lost opportunities if you stay too conservative for too long. There are better ways to hedge your bets than investing in so called conservative funds, but nobody asks the right questions.
- Mutual Funds are not always the best option for your investment funds, yet they are often the only option presented by advisors. Not a lot of people realize that RRSP money can be invested in stocks, bonds, real-estate, ETFs, and cash, to name a few. Again, you just need to ask the right questions.
3. How Do I Make A Withdrawal From My RRSP?
The hard truth on this one is that unless you are retired or facing bankruptcy (or using one of the approved economic incentives like the Home Buyers Plan), don’t. The second R in RRSP stands for Retirement and while it is technically possible the government has built in quite a few disincentives to taking the money out prior to retirement age.
- Withholding Tax: The financial institution where you made your RRSP contribution will hold back anywhere from 10-30% if your withdrawal and pay it in tax to the government.
- Income Tax: Any money received from your RRSP will be considered income for the year in which you take it out and could increase both your immediate tax payable and tax bracket for all other income as well. This could add up to a lot of extra tax at the end of the year.
If you anticipate needing this money for any purpose prior to retirement, don’t put it in an RRSP. TFSAs, non-registered investment accounts and simple savings accounts are far better short-term savings vehicles when you consider the tax consequences of early withdrawal.
4. What About Those Economic Incentives?
There are two scenarios in which you can withdraw money tax-free from your RRSP:
- Home Buyer’s Plan: You are permitted to take out $25,000 from your RRSP to make a down payment on your primary residence if you have not owned property in Canada in the past 4 years. The borrowed amount must be repaid back into your RRSP within 15 years or be considered taxable income.
- Lifelong Learning Plan: You are also allowed to borrow up to $20,000 over the course of your life for the purpose of education and retraining. The maximum a person can withdraw in any year is $10,000 and any borrowed amounts must be repaid into the RRSP within 10 years.
5. I’m Retired, What Now?
When you are ready to start taking money out of your RRSP as income you need to convert it to a RRIF. You can do this at any time, but it must be completed before December 31, of the year in which you turn 71 (mandatory dissolution age). Once converted to a RRIF you can no longer make any deposits to the account.
As money comes out of your RRIF it is taxed as income but because most people are no longer employed their income tax rate is lower in retirement than it was when they were working. The government also requires that a minimum amount comes out each year based on the individual’s age so that there isn’t a large sum left over when you die. This isn’t an exact science however a lot of people die with money still in their RRSP. It’s important to make provisions in your will and estate plan to deal with potential tax consequences if money is remaining when you die, but that is a discussion for another time.
Have you received your NOA yet? I hope you filed your taxes on time. If you have any questions about your RRSP contribution limit or how to take advantage of the many investment options available to you, feel free to reach out any time.
P.S. If you are looking for a quick snapshot of your financial security needs why not fill out my financial planning forecaster assessment at: https://form.jotform.com/211354286658058 I will get back to you with a financial security report within 48 business hours.