In my series of posts about retirement planning,  back at the beginning of August, I reviewed pensions, registered accounts, income funds and life annuities.

Today I am going to drill down a bit more on Registered Retirement Savings Plans (RRSP’s)

Currently you can contribute 18% of your income to a maximum of $24,270 (the limit can change each year).  The thing to note here is the Canadian Revenue Agency (CRA) will calculate your next years contribution limit each year when you submit your tax return.  The calculation for the upcoming year is based on the income reported on the submitted return.  Or more simply put, when you submit your 2013 tax return in April 2014, on the confirmation the CRA sends you back they will indicate the 2014 contribution limit (calculated based on 2013 income).

Some things to note:

– contributions to employer pension plans that are not taxed are counted toward the limit (say you contribute $6000 to the company plan through payroll deductions and your Registered Plan  limit was $24,000 than you only have $18,000 room left for your personal RRSP.  It does not matter if the employers plan is defined contribution or defined benefit.)

– additionally unused amounts from previous years are held over and accumulate.  So you don’t loose unused contribution room, it just adds to the next years 18% max $24,270 calculation,  making the contribution room higher.

Although you can calculate the maximum contribution limit the best way is to let the CRA do it for you.

Reasons for Contributing

As noted in my previous blog you defer taxes on the refund you get.  And you get the investment growth on the amount you contributed.

Another key value of your RRSP contribution is the tax refund you get, that is basically calculated as your marginal tax rate times the amount contributed.  You can use it to buy things (e.g., payment toward a new car) or you can invest it.

For future use (for example when you retire), investing the tax refund works best , that being said though using the refund to buy something you want now (a little luxury), but were not able to save up enough during the year, can be appealing too.

The bottom line is to make a conscious and informed decision  of how to best use your RRSP tax refund (basically invest or spend) in the context of your overall financial plan.

Contribution Strategies

Given unused contribution room accumulates in cases where your income is rising over time you can benefit by for example contributing extra savings to a TFSA initially instead of an RRSP and building your RRSP contribution room along side your income growth year over year.  Then at some point,  make a big contribution to your RRSP.  At this point assuming your income has put you in a higher tax bracket this maximizes your refund (which is based on your marginal tax rate).   The balance here is not to wait too many years as the value of the refund is having it to spend or save.

This strategy balances the contributions to both of the key Canadian savings vehicles that help reduce your tax burden (i.e., RRSP and TFSA).   The values and benefits of TFSA versus RRSP will be explored more fully in a future blog.