It’s almost the end of 2019 and perhaps somewhere in the back of your mind, you’ve started thinking about your RRSP strategy for 2020 to maximize your tax refund when you file your 2019 personal tax return. In this blog post, we’ll go over the different types of RRSPs, RRSP Contribution Limit and what is considered as Earned Income for the purposes of creating RRSP contribution room.
But first…let’s go over the basics.
The Basics of RRSP
What is a RRSP? A registered Retirement Saving Plan (RRSP) is a government sanctioned (Regulated Investment Plan) used as tax deferral vehicle and registered with Canada Revenue Agency (CRA) in accordance with rules set out in Income Tax Act. It is designed to help a taxpayer save for retirement by making tax deductible contributions. It’s a mutual contract between two parties – the Taxpayer and the Financial Institution. A taxpayer can contribute to RRSP plan and claim the deduction from the income in the year of contributions (subject to RRSP room limitation)
How do RRSPs work?
RRSPs are usually invested in financial products, which may earn interest, capital gains or dividends, depending on investment plan. RRSP provides following basic benefits:
- The taxpayer can deduct RRSP contributions and reduce taxable income in the year of contribution.
- Investment income earned within RRSP is sheltered from tax until withdrawn from the plan
- Although all withdrawals are fully taxed, many individuals have lower marginal tax rate (MTR) in retirement than they did during their working life. This creates a tax deferral opportunity, if planned properly, where you can get a refund in your high income years (at a higher tax rate), and pay lower income taxes in your years of withdrawal (at a lower tax rate).
Types of RRSPs:
1. Regular RRSP:
In the case of a regular RRSP, the taxpayer make contributions to their own plan and the funds are managed by financial institution or investment company.
2. Spousal RRSP:
Spousal RRSPs are another great tool available for taxpayers to save/defer taxes. It can be setup to split income for the purpose of saving on taxes in the years of retirement. The contributing spouse is normally the higher income earner. The purpose is to shift RRSP assets into hands of lower income spouse so that, at retirement, the income from the plan is taxed at a lower marginal rate, resulting in tax savings.
Spousal RRSPs are designed to help spouses equalize their taxable incomes during retirement. The contributing spouse can claim the deduction for the contribution (subject to available RRSP contribution limit). But the annuitant spouse will have to include any withdrawals from the plan in their taxable income, subject to spousal attribution rules (3 years after contribution). Spousal RRSPs are usually established when there is large gap in income between the two spouses.
Taxpayer can establish more than one spousal RRSP plans for his or her spouse, but for the purpose of spousal attribution rules CRA will view them as a single RRSP. A taxpayer can only contribute to his or her own RRSP until the end of year in which he or she turns 71 years of age. However if the taxpayer has younger spouse, the taxpayer can still contribute (subject to available contribution room) to spousal RRSP until the end of the year younger spouse turns age of 71.
3. Group RRSPs:
Group RRSPs are collection of individual RRSPs grouped together for administrative purpose. Typically sponsored by an employer, union or professional association. These types of RRSPs normally managed by financial institution, insurance companies or security dealer. Often, both employer and employees contribute to group RRSP, with the employer matching employee contribution up to a certain limit or percentage of income.
4. Self-Directed RRSP:
A self-directed RRSP gives you freedom to build and manage your own investment portfolio by buying and selling a wide variety of different types of investments. Under self-directed RRSP account, an investor can hold various different investment. Whereas a regular and spousal RRSP is normally administered by a trustee (investment company or a financial institutions), a self- directed RRSP is entirely managed by the taxpayer. Individuals should consider opening self-directed RRSPs only when they:
- Have the time and knowledge to manage own investments, or have access to professional investment advice;
- Have large deposit-based RRSP;
With a Self-directed RRSP, an individuals has the opportunity to tailor their portfolio in an effort to obtain the highest possible return.
RRSP Contribution Limit for 2019:
Are you wondering how much you can contribute to your RRSP before the 2020 deadline?
Total contribution room is the amount you are allowed to contribute to your RRSP. Your total contribution room is 18% of your previous year’s Earned Income, up to the maximum contribution limit, adjusted for carry-forward contribution room and pension related items. To take full advantage of this tax deferred vehicle, contribution should be made as early as possible in the calendar year. Contribution made between March 2nd of the current year and March 1st (February 29th in case of leap year) of the following year can be claimed on the current year’s tax return up to available contribution limit.
Employer sponsored pension plans (RPP’s) or Deferred Profit Sharing Plans (DPSPs) reduce tax payer RRSP contribution limit.
RRSP Deduction Limit for 2019:
The RRSP deduction limit for 2019 is 18% of taxpayer earned income for 2018 or $26,500 whichever is less. For example if your earned income for 2018 was $75,000, then your RRSP deduction limit is 18% of $75,000 = $13,500, which is less than maximum contribution limit set by CRA.
Past RRSP Deduction Limits:
|Year||RRSP Deduction Limit|
The RRSP deduction limit differs from RRSP contribution limit as it does not take into account past unused RRSP contributions. Most people don’t make the maximum RRSP contribution every year. This unused amount is carried forward and added to available contribution room for future years. Your contribution limit can be seen on your latest notice of assessment or reassessment from CRA. Screenshot below is an example.
What is Earned Income for RRSP?
RRSP contribution limit for 2019 or any given year depends on Earned Income for the previous year. This includes active income such as employment income and business income, but does not include most type of passive income (i.e. interest, dividends and capital gains)
Type of income that qualifies for RRSP earned income:
- Salaries and wages, net of employment expenses claimed, RRP;
- Net income from self-employment;
- Royalties for a work or invention;
- Net rental income from real property;
- Research grant;
- Alimony and maintenance received and,
- Foreign employment income.
Earned Income is reduced by following items:
- Current year business loss;
- Current year Rental Loss;
- Alimony and support paid.
Passive Income which do not qualify for RRSP contribution limit calculation:
- Investment income;
- Taxable capital gains;
- Death benefits;
- Scholarships and bursaries;
- Employment insurance benefits.
Note that CPP disability payment is considered to be earned income.
RRSP Contribution Deadline for 2019:
In one of our blog posts on CRA deadlines, we covered several deadlines that apply to Canadian individuals and corporations. As far as RRSPs are concerned, your deadline to contribute is March 2, 2020 in order for that contribution to be applied against your 2019 income.
The rules around RRSP can be quite complex and go far wide and deep. We’d be happy to help you navigate this maze. Reach out to one of us at firstname.lastname@example.org or call us at 905-565-0095!