The RRSP season is here, those two-months at the start of the year when banks try and tempt you with their RRSP investment products. But why are RRSPs important and how can you get the most out of them?
What the season means if you’re still contributing
You have until March 1 to contribute to your RRSPs and get a tax rebate on last year’s income. For example, let’s say you earned $50,000 in gross income last year (before tax) and you decide to contribute $10,000 to an RRSP before March 1 of the following year. That reduces your before tax income for the prior year to only $40,000 ($50,000 – $10,000). When you file your taxes after March 1, you will receive a tax rebate for the difference between paying taxes on $50,000 and paying taxes on $40,000. This assumes that you have at least $10,000 of contribution room.
Your contributions are tax-deferrable, which means that they effectively reduce your income and you pay less tax.
You only pay tax when you withdraw the money. Given that this usually happens when you are retired, the chances are you will be earning less, be in a lower tax bracket and therefore, paying less tax than when you were working.
If you are not financially prepared for retirement, you may not be able to enjoy these years to the fullest. If you think you may not have sufficient savings then don’t worry, there are ways you can prepare for your retirement without the burden of any monthly mortgage payments.
How much can you contribute?
The most you can contribute is either 18% of your income or $26,500 (for 2019) – whichever is lower.
However, you can carry unused contributions forward to next year. You can find out the exact amount you can contribute by checking last year’s notice of assessment or your Canada Revenue Agency account.
What if you don’t have much spare money to contribute?
You could take out a short-term, RRSP loan. You borrow money to make contributions to your RRSP account.
If you can pay off the loan fairly quickly, your tax rebate could more than make up for the loan interest. For example, a one-year RRSP loan of $2,500 at 4.75% would cost you $64.76 in interest over the year. However, your tax rebate on a $2,500 RRSP contribution would be $1,000 if you are paying tax at 40%.
What are the benefits of contributing?
Your money can grow quickly in an RRSP account. You receive a tax rebate on the contributions, which you can add to your savings. Also, any growth in your investments (such as interest, dividends and capital gains) is tax-free.
The benefits of compounding interest are on your side when you start to save for your retirement early. Over the years, you earn interest on the interest.
Saving a substantial amount in your RRSPs early can make a huge difference when it comes to retiring. Let’s say you save $500 per month and, on average, your investments bring a 6% annual return.
If you started saving at age 30, you would have saved just over $500,000 by the time you retire at 60. If, however, you waited until you were 50 to start saving, by your 60th birthday you’d have just over $82,000. By saving three times longer, you reap over six times the amount of money.
RRSPs once you reach 71
You will have to transfer your RRSP funds into a registered retirement income fund (RRIF) or annuity when you reach 71. The following year, you will need to start withdrawing money from your RRIF (unless you have a younger spouse, in which case you can wait until their 71st birthday).
There is no real advantage to switching your RRSP to a RRIF until you’re 65. At that point, your RRIF payments will be eligible for up to $2,000 in tax credit and pension income-splitting with your spouse. Otherwise, withdrawals from RRIFs are considered income and will be taxed accordingly.
Once you convert your RRSP into a RRIF, you have to withdraw a minimum amount each year, which increases as you get older. For example, at 71, you must withdraw 5.28% of your total investments and at 85 this number goes up to 8.51%.
What if you haven’t contributed enough to your RRSPs?
If you’re approaching or are in retirement and find that your savings don’t provide enough for the lifestyle you want, there is a solution.
The CHIP Reverse Mortgage® from HomeEquity Bank allows you to take out a tax-free loan by leveraging the equity of your home and use that money as retirement income. You don’t have to make mortgage payments, so this provides a big boost to your cash flow.
Find out how the CHIP Reverse Mortgage can help you to fill the shortfall in your retirement savings by using our reverse mortgage calculator, or call us at 1-866-522-2447 and see how you can live retirement your way.