Quick – what happens this Monday at midnight?
You lose the ability to make an RRSP contribution that will be deductible from your 2015 income on your 2015 tax return. February 29 is this year’s cut-off date, 60 days after year end.
I am bringing this up at this late date because many people have still not made such a contribution, and many are still undecided on the value for their situation. This column will help.
If you have made your 2015 contribution, and are contemplating your strategy for 2016, this may help you, as well.
All of us, except the independently wealthy, have to put money aside for our retirements. So, when I ask the question, “Is the RRSP the right vehicle for you?”, let’s agree that if the answer is no, then you still have to choose an alternate vessel into which you place investments to fund your future retirement. Answering “no” does not get you off the hook.
There are great benefits to RRSPs, assuming you are the middle or higher tax bracket. One benefit is the reduction in taxable income that results from a contribution. This reduces tax for most people, and provides them the opportunity to use that tax reduction to increase their savings capacity.
As investments inside an RRSP grow, there is no tax on the investment income or growth in the RRSP account, allowing the investments to compound tax-free until withdrawn.
RRSP, TFSA or non-registered account?
Your choice of investment “location” (RRSP, TFSA or non-registered investment account) depends on a number of factors. The most important ones are your current marginal tax rate, and the rate at which you expect to be paying tax when you will be withdrawing money from your accounts in the future.
Higher tax rate taxpayers (say, those with more than $67,000 of taxable income after deductions) receive a higher immediate tax benefit for an RRSP contribution than people in the first two tax brackets, but will often be taxed at a higher rate when they withdraw the money in the future.
Let’s look at some contribution benefits, which are based on a person’s marginal tax rate. (We are using combined Manitoba and federal tax rates here.) For a person with taxable income of $20,000, the tax saving is 25.8% of the RRSP contribution. This means that a $1,000 contribution reduces taxes by $258. This goes up to $277 for taxable incomes up to $45,282.
At those tax brackets, it is worth considering the TFSA instead of the RRSP as the vehicle in which to place your investments.
The tax saving for RRSP rises to 33.25% for taxable incomes between $45,282 and $67,000, 37.9% for taxable income under $90,563 and 43.4% for taxable income up to $140,388.
People with taxable incomes between $140,388 and $200,000 are paying tax on that income at a rate of 46.4%, so this is also the rate at which they save taxes by making an RRSP contribution.
Our new federal government has introduced an extra 4% tax for 2016 on incomes above $200,000 taxable, and so 50.4% will be the tax rate and the saving for contributing to an RRSP for 2016. This rate does not apply for 2015.
All withdrawals from RRSP (or RRIF) add to taxable income, and taxes are applied at the same rates as above. RRSP withdrawals also add to net income, which is the figure the government uses to calculate a range of income-tested benefits, including OAS, the Guaranteed Income Supplement, GST tax credit and others.
If you are in one of the top tax brackets now, RRSP is likely your first choice, and then re-invest your tax saving, either to pay off debt or contribute more to RRSP.
In the lowest tax brackets (up to $31,000 taxable), the RRSP contribution may save you less tax now than the withdrawals will cost you down the road in retirement. For you, the better choice is likely the TFSA or even a non-registered investment account, using the appropriate proportion of equity investments for your situation.
In all cases, though, the right decision is to do something.
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Dollars and Sense is meant as an introduction to this topic and should not in any way be construed as a replacement for personalized professional advice.
Please consult legal, tax, insurance and investment experts for advice on your unique situation.
David Christianson, BA, CFP, R.F.P., TEP, CIM is a Certified Financial Planner and senior advisor with Christianson Wealth Advisors, a Vice President with National Bank Financial Wealth Management, and author of the book Managing the Bull, A No-Nonsense Guide to Personal Finance.