How High-Income Earners Can Legally Reduce Their Tax Rates Buying RRSPs

What is an RRSP?

To start with it would be useful to recap the basics of RRSP, especially for those who are new to this concept. RRSP stands for Registered Retirement Saving Plan which was introduced to Canadians back in the 1957 for the purpose of helping Canadian residents save for their retirement. RRSP is a tax-sheltered account that enables the Canadian residents to save “tax free” while the money stays within the plan, meaning it reduces your tax rates in the meantime when you are employed, deferring the tax liability to a later date, when you stop working and start using your retirement savings. With a good financial advice, your everyday expenses in retirement should be significantly lower once your mortgage is paid off and your kids have left the family nest, earning income of their own. Hence your income from your investments from sheltered RRSP account would be taxed at a much lower tax rate then you might be today.

Benefits of RRSP?

To recap, following are the major benefits of contributing to your RRSP account:

• Tax Deductible – Your annual RRSP contribution will be deducted from your annual income, allowing for an immediate tax deduction. The mount invested in your RRSP is in fact an amount before tax.
• Tax Sheltered Income – Your investment grows tax free as long as it stays within the RRSP account
• Deferred Tax – As we mentioned earlier, making an RRSP contribution can enable you to lower your tax bracket, hence reducing your tax liability for the current tax year in which you contributed. By making an RRSP contribution you are essentially deferring paying taxes on the principal of the investment to a later date and the same applies to the proceeds of the investment growth within the account.

What Assets Qualify to be Invested in the RRSP?

Following is the list of assets allowed to be held in your RRSP account:

• Cash
• Guaranteed Investment Certificates (GICs)
• Savings Bonds
• Treasury Bills
• Bonds (including government bonds, corporate bonds and strip bonds)
• Mutual Funds (only RRSP eligible ones)
• Exchange Traded Funds (EFTs)
• Equities (both Canadian and Foreign Stocks)
• Canadian mortgages
• Mortgage-backed securities
• Income trusts

Investments excluded from being invested in RRSP account include:

• Precious Metals
• Personal Property such as arts, antiques and gems
• Commodity Futures Contracts

RRSP Limitations

Time Limit – You can contribute to your RRSP anytime throughout the current tax year. If you haven’t utilised your RRSPs contribution room in 2017, or you still have an RRSP room that would enable to lower your tax bracket, you have up to 60 days after the tax period is finished to contribute. Any contributions made between March 2^nd and December 31^st can only be applied for the current tax year.

Age Limit –  Anyone who reaches the age of 71 and above can no longer make RRSP contributions. Any money in RRSP requires to be transferred into RRIF account or another form of retirement income fund accounts.

Contribution Limits – Everyone’s RRSP contribution is limited to 18% of their previous year income, up to a total of $26,010 (a maximum contribution amount for the 2017). Each individual total maximum contribution amount equals to a combination of their cumulative amounts from the previous years together with the current year’s contribution. The contribution amount requires to be adjusted by the person’s Pension Adjustments. (+/-).

You don’t need to worry about calculating the right contribution amount. The CRA will send you a Notice of Assessment that will inform you of the RRSP contribution amount that you are eligible to contribute that year, based on the income you reported in your last years income tax return. Following picture is a sample illustration of how the deduction limit is calculated on your Notice of assessment:

Calculating correct amounts can seem confusing and to benefit from the tax planning using RRSP contributions contact Ke Wang Certified Public Accountants who would be happy to assist you.

Different Types of RRSP Accounts

• Personal RRSP

Personal RRSP is an account registered in your own name. You can choose to set up and manage your own RRSP portfolio or you can get guidance of an experienced licensed adviser.

• Spousal RRSP

Spousal RRSP is an account you can register in your spouse’s/ common-law partner’s name. They own the account, but the contribution amount is based on your own RRSP contribution limit to reduce your tax liability. The amount contributed in the spousal RRSP reduces your own RRSP contribution room, while your spouse’s contribution remains unaffected.

Spousal RRSP is a way to distribute income tax between the spouses more evenly during the retirement when the household income is likely to be much lower than the RRSP income along, hence making your money working for you longer.

Spousal RRSP is a great way reducing your income tax liability when your income is in a higher tax bracket. It is also a good strategy when your employer offers a pension plan as part of the employee benefits package and your spouse does not have that sort of benefit.

In order to qualify for a Spousal RRSP, you must:

• Have been living together as a couple or living together for at least 12 months
• Have a child together or adopt one together
• Have a shared custody of your ex-partner’s child or joint financial support

If your spouse withdraws the money you deposited into Spousal RRSP:

• Within 3 years from the time you made the Spousal RRSP contribution, the contributor is liable for the tax portion of the money withdrawn
• After the 3 years of making the spousal RRSP contribution, the money is taxed based on the spousal tax bracket

In the event of ending the relationship/marriage, If the marriage is ended prior to the divorce under normal circumstances, spouses are required to distribute the assets equally. If the spouses cohabited before the divorce was completed, it would be advisable to draft a joint agreement so the assets won’t be split equally, but based on the agreement.

Overall, it is only beneficial to contribute to a spousal RRSP when your spouse’s retirement income would be significantly lower and it would allow you to balance retirement income and reduce the tax liability during your retirement. When both spouses’ incomes are roughly the same, it does not make much of a sense to contribute to a spousal RRSP.

• Group RRSP

Some employers offer their employees a Group RRSP as a form of benefit, to support their retirement savings. Equally, you can open a personal pension account, and your employer can deposit allocated amount there. The group RRSP for all employees is held with the same financial institution. The benefits of Group RRSP are as followed:

• Employee contributions are usually deducted directly from an employee’s salary before any tax is applied; hence benefiting from the regular contributions and highs and lows of market fluctuations and benefiting of the extra time your investments work for you
• Your employer will make the agreed or matching RRSP contribution directly in your group RRSP account.
• The employer usually covers the costs of the opening and managing the group RRSP plan
• Employees are responsible for covering the investment administration costs.
• Investment range in Group RRSP account is often limited and depends on the terms of the Group RRSP.
• Withdrawing money from the Group RRSP is often limited to the account rules, usually set by the employer.

• RRSP Overcontribution

If you accidentally overcontribute to your RRSP, you will pay 1% per each month since you overcontributed to your RRSP. The government will only tolerate $2,000 overpayment, so it is very crucial to pay attention and follow the RRSP limits to avoid paying high penalty charges for overcontributing.

• RRSP Withdrawals

At any time, RRSP holders may withdraw the funds from their RRSP account, regardless of their age. However, the withdrawn amount will be included in the current year’s taxable income.

The RRSP account must be closed before the December 31^st the year the RRSP holder turns 71 years of age. The RRSP owner has following options:

1. Cash out
2. Convert to Registered Retirement Income Fund (RRIF)
3. Turn it into an annuity