RRSP’s – How do they work?

RRSP’s – How do they work?

Since we are coming into RRSP season, it’s time to take a look at RRSP’s. Many people know what RRSP’s are, but they do not know how they work or even know if it is a suitable product for them to use.

So, it begs the question – what are RRSP’s and how do they work?

Simply put, RRSP’s (Registered Retirement Savings Plans) are a vehicle to help you save for retirement. Here are some highlights of what RRSP’s are and do:

Contribution Room – 18% of your employment income opens up “RRSP space” for you to contribute. “RRSP space” carries forward into future years until you use it up by making RRSP contributions equal to your maximum contribution amount. Here is a simple example: you earn $10,000 in employment income for the year. 18% of $10,000 is $1,800. This is the “allowable contribution room” for an RRSP. You can find how much “room” you have by looking at your Notice of Assessment of the latest year’s tax filing.

People with Registered Pension Plans – People who are contributing to registered pension plans while still working will have a “pension adjustment” for the purposes of contributing to RRSP’s. Simply put, the pension adjustment lowers your eligible RRSP room.

Contribution Period – Contribution times to an RRSP run from early March until the first 60 days into the next year. This is why January and February are considered “RRSP season”!

Immediate Tax Benefits – RRSP’s help lower your taxable income. For every dollar you contribute lowers your taxable income by that same dollar. For example, you earn $30,000. Using only Federal Tax Tables, you are in the 15% tax bracket. If you make a $1,000 RRSP contribution, your taxable income is now $29,000 ($1,000 less than before the RRSP claim). You will get at 15% tax credit federally, amounting to a $150 tax credit on your return. Provincial eligibility and percentage amounts will vary from province to province.

Interest Grows Tax Deferred Until Retirement – So long as you do not pull out your RRSP’s for any reason (and I know there are good reasons, like using the Home Buyer’s Plan, Lifelong Learning Plan, or to eliminate necessary debts, etc., I will blog more about HBP’s and LLP’s later), interest grows inside the RRSP product tax deferred. This means you will not be paying taxes on the interest or principle until you reach the age of 71 and must convert the RRSP into a Registered Retirement Income Fund (RRIF) or an annuity. Usually, the tax bracket you will be in at retirement is lower, hence paying lower taxes at that time when drawing out your retirement funds.

If you wish to know more about RRSP’s, please contact your financial advisor. If you don’t have one and live in the Greater Victoria area, e-mail me at toserveyou@seianna.com. I will recommend someone to you.

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