Get the Most Out of Your RRSPs

RRSPs are a key building block for retirement income. Consider the following strategies to get the most out of them.

1. Start Contributing to Your RRSP as Soon as Possible

By starting when you are young, you maximize the advantages of compounding and reduce the pressure to save aggressively when you’re older. Consider three individuals who want to have $135,000 when they reach the age of 65, as shown below.

Start age

Monthly Contribution

30

$95 per month

40

$193 per month

50

$456 per month

Assumes 6% rate of return

2. Contribute to Your RRSP Early in the Year

Assume Terry and Pat both contribute $5,000 per year to their RRSPs, starting at age 25, and earn an average rate of return of 6%.

 

Terry

Pat

A contribution made at:

Value of RRSPs at Age 65:

End of Year

$773,800

Beginning of Year

$820,200


By contributing at the beginning of the year, Pat's RRSP grows an extra $46,400!

3. Contribute Regularly to Your RRSP

Not many people have several thousand dollars sitting around, particularly right after Christmas. By contributing regularly, you avoid the pressure of having to find the money for your annual RRSP contribution by the end of February.

Also, by incorporating a monthly RRSP contribution into an investment strategy, a person is more likely to stick to their investment plan. Since you contribute in regular intervals, you can benefit from the advantages of “dollar-cost averaging”. The purchase price is averaged, taking out the market peaks and valleys.

A bonus of regular contributions is that these regular contributions begin earning income right away. With regular contributions, you can apply to reduce your taxes at source, which means more money each month versus waiting for your tax refund the following year!

Contributing to an RRSP isn't the only way to reduce your tax bill. Check out ProsperiGuide's tax tips.

4. Contribute to Your RRSP Every Year

Contributing to an RRSP every year is a challenging goal for most people because some years are better than others. However, skipping a year of RRSP contributions means that you lose the deferred accumulated growth this money could have earned, both in the current year and in the future.

Don’t despair, as all is not lost. If you cannot contribute in a particular year, your unused RRSP contribution room may be carried forward indefinitely.

5. Maximize Your RRSP Contribution

Contribute the maximum amount to your RRSP and catch up on any unused contribution room. By doing so, you build more funds for your retirement, tax shelter more of your investment earnings and reduce the taxes payable on your current income. There is also a hidden advantage: money invested inside your RRSP accumulates faster than if it were outside your RRSP because the investment income is compounding free of current tax.

6. Know Your Contribution Room

The maximum annual RRSP contribution for each employee is 18% of earned income in the previous year, to a maximum of  $27,230 for 2020, $27,830 for 2021 and then indexed from 2022 onwards. However, this amount includes all forms of tax-assisted savings. When you receive tax-deferred benefits from an employer’s pension plan, a pension adjustment (PA), based upon the benefit earned from these plans in the prior year, reduces your current RRSP room. The PA for the company pension plan is reported on the T4 form that you receive each year.

Impact of a Pension Adjustment

Since a defined benefit (DB) pension plan produces a relatively generous pension benefit for employees and because of the way the pension benefit is valued, employees have only a modest amount of room available for RRSP saving. If you leave a DB pension before retirement and do not receive an amount equal to your total pension adjustments from your pension plan plus any past service pension adjustments, a pension adjustment reversal (PAR) will restore the lost RRSP room.

Defined contribution (DC) pension plan participation does not reduce RRSP room to the same degree, since the RRSP deduction is based upon actual contributions, not upon the future value. You can only receive a pension adjustment reversal from a DC plan if you are not fully vested at termination (that is if you cease to have entitlement to any part of your pension that was previously included in your pension adjustment).

7. Spousal RRSPs

Contributing to a spousal RRSP can be effective if your spouse is in a lower tax bracket and/or can be expected to be in a lower bracket in retirement, particularly if you plan on retiring prior to age 65 and want to tap into this money for income.

  • You receive the deduction for the contribution at your current marginal tax rate, just as you would for a personal RRSP contribution.
  • Before age 65, any income received is taxable to your spouse in his or her lower tax bracket.
  • It minimizes the amount of tax burden on the family.
  • If your spouse is younger, you can continue contributing to his/her RRSP after you’ve reached age 71.

Canadians over the age of 65 may split income from registered income vehicles such as RRIFs.

There are two cautions with spousal RRSPs:

  1. If your spouse makes a withdrawal within three calendar years of making a contribution to any RRSP, you have to pay the tax on any amount up to the total contributions made to any spousal RRSP over this time period; and,
  2. Special conditions may apply in the event of marriage breakdown.