A registered retirement savings plan (RRSP) is a smart way to invest money. Anyone with qualifying income (which includes salary, wages, alimony and rental income) may contribute to an RRSP and may also select the type of investment. The federal government allows an individual to contribute up to 18% of the previous year’s income (with a dollar ceiling) to an RRSP eligible investment, which is tax-sheltered until the money is withdrawn. Contributions are tax-deductible. Withdrawals are generally treated as taxable income.
People often delay making their RRSP contributions until the last moment (February of the following tax year). However, saving one’s pay in an RRSP as the money is earned is not only good investment discipline, but it also accomplishes the following two money-saving tasks:
In using an early/continuous investment strategy, it’s also possible to reduce the tax, which is automatically deducted from your paycheque.
If you have not had an RRSP before, the following guidelines may help you.
It makes sense to take advantage of every opportunity to invest money in an RRSP due to its tax-sheltering advantage. Since the 1991 tax year, Canadians are allowed to “carry forward” unused RRSP contributions. If you have not contributed to your RRSP up to the maximum limits allowed in any of the years since 1991, you may carry forward these amounts that constitute your “unused” RRSP contributions up to age 71. Generally, taxpayers, in a high marginal tax bracket, should maximize their RRSP annual deduction limit.
Consider making additional contributions to use up any previous carry forward room. One strategy is to divide this amount by the number of years to retirement. Then, try to save that amount each year (on top of your annual limit), so you can maximize your contributions by retirement.
If in any year you maximize your current year’s RRSP contribution and make an additional contribution for a previous year’s unused contribution, you may deduct the full amount that you contributed from your taxable income. By putting a plan in place to use up your carry forward room, you are able to capitalize on the greatest advantage of an RRSP, which is the compounding effect of the tax-sheltered income.
You can also carry forward your deduction. Depending on your marginal tax rate, if you make a large contribution in any one year, it may not make sense to deduct all of it in that year. Evaluate if you’d be better off to carry forward the unused deduction to a future year.
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