Tax Tip Thursday

Opportunities and pitfalls of RRSPs

An Registered Retirement Savings Plan (or RRSP) is one of the most powerful tools Canadians have for saving for retirement, buying a home or even funding education while also lowering their annual taxable income in the short-term. But many people may not know the best way to get the most out of their RRSP, which can result in some questionable choices that leave easy money on the table.

Here is a closer look at some of the weird RRSP choices Canadians make, along with tips on how to avoid these all-too-common mistakes to get more out of your hard-earned money.

1. Waiting for a higher-earning tax year to contribute

Problem: It’s tempting to delay contributing to your RRSP until you make more money, assuming you’ll be in line for a bigger tax break when your income is higher. But here’s the catch: waiting until tomorrow to contribute means losing out on tax-deferred growth today. Even if you do not claim your full deduction right away, your investments will start compounding sooner, which can make a big impact in the long run. Compound interest is one of the most powerful forces you can use to grow your wealth, and the sooner you start, the better off you’ll be.

How to avoid: Instead of waiting, contribute to your RRSP as soon as you’re able. And don’t make the mistake of thinking you have to use the corresponding deduction immediately — you can carry it forward to a higher-income year while still letting your investments grow tax-free in the meantime.

This is a line of thought that some financial advisors and accountants share.  I am NOT one of them.  The contribution strategy that I recommend is if you have TFSA room and you are at the beginning of your career with lower earnings, you should make sure your TFSA is maxed out.

By contributing to your TFSA, you will accomplish the same thing in terms of the compounding effect of investments, but it will allow you to save your RRSP deduction room for when your tax rate is higher and benefits you significantly more financially.

Withdrawals from a TFSA are tax free for life!

2. Not taking advantage of RRSP matching

Problem: One particularly head-scratching mistake is leaving money on the table by not utilizing RRSP matching.

How to Avoid: Many employers offer RRSP or TFSA matching programs.  This is free money!  I cannot think of a single reason NOT to take advantage of free money!

While they lower the amount of money that you can contribute to your RRSP in a given year, it is only because, they are making the contribution on your behalf.

If you want to look at it in terms of return on investment – you are literally doubling your money to the extent of the matching!

Please do not pass up this opportunity.

3. Not using the higher-income spouse’s RRSP room first

Problem: Many couples contribute to their RRSPs separately without realizing they could further optimize their tax situation by prioritizing the higher-income earner’s contribution room first. Since RRSP deductions lower taxable income, maximizing the higher earner’s RRSP space can result in a bigger immediate tax refund.

How to avoid: If your spouse earns significantly more than you do, consider contributing to their RRSP first to maximize tax savings.

Another option is to open a spousal RRSP, so the higher income earner can contribute, while the lower-earning spouse can make the withdrawals in retirement at a lower tax rate — helping you both make the most of your tax benefits while growing your nest egg.

The bottom line

Your RRSP is one of the best tools available for balancing tax savings while building long-term wealth — but only if you use it wisely. By avoiding these common mistakes, you can maximize your savings, minimize your taxes and set yourself up for a better future.

Let us help you make the best decisions for your RRSP contributions! Make An Appointment today!

Disclaimer:

This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal or tax advice nor can it or should it be relied upon. All tax situations are specific to each individual. If you have specific tax questions you should book an appointment for a 1 on 1 consultation.