The government’s Registered Retirement Savings Plan (RRSP) is one of the most significant savings vehicles in Canada. Not only does it help you save for retirement, but it also lets you reduce your tax liability during your higher income years.
Whether retirement is 5 years or 25 years away, it’s imperative to have a strategy that allows you to reach for your goals. Here are some tips to help you get started:
Contribute early
The earlier you start contributing to your RRSP, the earlier you can retire. This is because your money will start compounding sooner and grow faster. Not to mention, if you’ve just started working, it’ll help you get into the habit of saving. Even if it’s just a couple hundred dollars a year, you’ll still develop a mindset that will make saving a habit.
Maximize your contributions
In order to take full advantage of the tax deductions that come with contributing to your RRSP, make sure to use your full allowable contribution every year. If you aren’t able to, however, you may have accumulated unused RRPS contribution room, which the Canadian government notes can get carried over the next year. You can also contribute back to this in two ways: contribution in kind or an RRSP loan. Contribution in kind involves transferring funds from non-registered investments such as mutual funds into your RRSP.
Avoid withdrawals for short-term debt
While you’re free to access and withdraw your RRSP even before retirement — there are some consequences. For one, you could incur tax penalties for withdrawing your RRSP early. There are two types of taxes that get deducted: marginal and withholding tax. Marginal tax is the combined federal and provincial taxes you pay on income at tax time, while withholding tax is money withheld by your financial institution and passed to the CRA. For the latter, you can get taxed 10% to 30% depending on how much you withdraw. For this reason, it’s best to have a mindset that money in your RRSP is money that can’t be touched.
Be smart about claiming your deductions
Contributing to your RRSP within your limit will entitle you to a deduction on your tax return — but you don’t need to claim it the same year you make the contribution. Take advantage of this by deferring your deduction if you expect your income to increase, as it will push you into a higher tax bracket and subject you to a higher marginal tax rate. For instance, if you’ve earned $75,000 in 2019 and live in Ontario, a $10,000 deduction will save you $2,965 since your marginal tax rate is 29.65%. If, in 2020, you make $100,000, that same deduction will save you $3,838 (almost 30% more).
Overall, an RRSP is a smart way to start saving for retirement while reducing your taxable income. By starting early, strategically contributing to your RRSP, avoiding early withdrawals, and being smart about your deductions, you can retire early and enjoy a comfortable life sooner than you planned.
