RRSPs - The Tax Shelter of Choice!

 

You are no doubt already aware that the RRSP is the tax shelter of choice, the first step on the way to good financial planning. But did you know just how much you can benefit from an RRSP?

The main advantages of an RRSP are the taxes that are saved in the year the contribution is made and the tax-free growth of the principal, which means it will build much faster. Only when you decide to withdraw the proceeds from the RRSP will you have to turn over a portion to the various levels of government, but you are generally in a lower tax bracket when you do so. Since for most of us income tax will be the largest expenditure confronting us in our lifetimes, the RRSP does have some rather significant benefits if you take full advantage of what it has to offer.

The amount of the tax credit governments contribute to your savings is based on the level of your taxable income and, of course, your contribution. Since tax rates are progressive, the higher your taxable income, the more governments will contribute to your savings.

For 2001, you can contribute to your RRSP an amount equal to 18% of your earned income in 2000 up to a maximum of $13,500. If you are paying into your employer's registered retirement plan, which is the case for members of the CF, your maximum contribution is reduced by the pension adjustment (PA) appearing on your T4 for the year 2000. If you have not used all of your contribution credits since 1991, you will be able to do so this year or some other year, since unused allowable contributions can be carried over from one year to the next.

You can contribute a maximum of $2,000 over and above your RRSP limit. By doing so, you will take advantage of the additional investment income that will be generated tax free. The earlier this excess contribution is made, the more effective this strategy will be for you. Talk it over with your financial planner to ensure that this approach is the right one for your financial situation.

Begin contributing as early in life as you can, i.e., as soon as you begin earning an income. You can contribute periodically throughout the year and even if the amounts you are investing are modest, if you do so over a 30- or 40-year period, what you will have accumulated by retirement age will be impressive indeed. For the 2001 taxation year, you have until March 1, 2002 inclusive to contribute to your RRSP. However, from now on, make it a habit to contribute at the start of the year, if you have the funds available, to earn even more investment income in the plan where it can build tax free. If you apply these rules, you will add substantially to your RRSP.

You must ensure that you have a diversified investment portfolio, because effective diversification maximizes return and minimizes risk. A diversified portfolio normally includes three types of securities - liquid assets (e.g., Treasury Bills and banker's acceptances), fixed income securities (e.g., GICs and bonds) and growth securities (e.g., Canadian and international shares). You can purchase these securities directly or invest through mutual funds. Note that the federal government has placed a 30% foreign content limit on each of your RRSP accounts. The proportion of each of these types of securities in your portfolio must be determined based on your investor profile. Your financial planner can help you establish your profile using a questionnaire designed for this purpose, and give you advice on sound investment choices.

Yes. If you anticipate that your spouse's retirement income will be less than yours, you should consider contributing to his or her RRSP. That way, when the funds are withdrawn, they will be taxed in the hands of the spouse with the lowest income, resulting in considerable tax savings.

The good news is that, as a contributor, you will still get the tax deduction, even though the savings are registered in your spouse's name. Moreover, this does not affect in any way the contribution your spouse can make to his or her RRSP.

Those of you who end up in a situation where the income will be unevenly distributed at retirement and have not made adequate plans to address this issue will be taxed at a rate that is higher than necessary. How can we get around this? This will be the subject of our next article to be published in February, which will also discuss those circumstances where there is some advantage to borrow to contribute to an RRSP.

Written by : Renée Trépanier, CFP
Personal Financial Management Educator
SISIP Financial Services, Ottawa