Tax season has started and that means British Columbians are trying to make sense of tax changes and how to handle their RRSPs. The Chartered Professional Accountants of British Columbia (CPABC) has put together five important RRSP tips for the 2015 tax year:
1. Who is Eligible to Contribute to an RRSP?
Anyone with “earned income” in a prior year who is subject to Canadian taxation on that “earned income”, including non-residents, may contribute to an RRSP. You can make part or all of your RRSP contributions to a spousal RRSP under which you are the contributor and your spouse is the annuitant, and you as the contributor are entitled to the tax deduction. For this purpose, a spouse refers to a legally married partner or a common-law partner of the opposite or same sex with whom you have cohabitated for the past 12 months.
To maximize your long-term tax savings, there should be an attempt to equalize the retirement income of both spouses. Therefore, RRSP contributions should go into the name of the spouse who will otherwise have the lower income in retirement. There are, of course, exceptions to this general rule where, for example, both spouses are trying to accumulate funds for the Home Buyers’ Plan or the Lifelong Learning Plan.
2. Tax Savings from an RRSP
If you have an RRSP deduction limit as shown on your 2014 Notice of Assessment and you are a B.C. resident, the following are the income tax savings you could realize from making an RRSP contribution:
- If your taxable income is between $11,327 and $44,701, a $1,000 RRSP contribution would reduce your 2015 taxes by up to $227.
- If your taxable income is between $44,702 and $89,401, a $1,000 RRSP contribution would reduce your 2015 taxes by about $227 to $343.
- If your taxable income is between $89,402 and $138,586, a $1,000 RRSP contribution would reduce your 2015 taxes by about $343 to $407.
- If your taxable income is over $138,587, a $1,000 RRSP contribution would reduce your 2015 taxes by about $437 to $458.
Remember, an RRSP is a tax deferral vehicle–you will be taxed on the funds when withdrawn. That said, you would rather pay $1 of income tax tomorrow than $1 of income tax today. Actual tax savings will result if you are in a lower tax bracket when you withdraw the funds, or if you can save income taxes by moving taxable income to a lower income spouse through a spousal RRSP.
Look into the amount you can save with an RRSP contribution today.
3. Early Contribution to an RRSP
RRSPs can be tax-effective investment vehicles, especially if you are many years from retirement. If you do decide to take advantage of an RRSP, it is advisable to contribute at the beginning of the year to start the tax-free compounding of earnings within the RRSP earlier. Also consider monthly contributions to your RRSP throughout the year as opposed to a lump sum contribution at the end of the year or in the first 60 days of the following year.
You can make an RRSP contribution in a year and not claim a tax deduction in that year if you think your marginal tax rate will be higher in a later year. You will still benefit from the tax-deferred earnings. Provided your undeducted RRSP contributions do not exceed your RRSP deduction limit plus $2,000, your undeducted contribution can be carried forward indefinitely, without penalty, for deduction in future years. This could be a substantial advantage if you claim the tax deduction in a year or years when you are in a higher tax bracket.
For your RRSP contribution to be deductible for a particular tax year, the contribution must be made by the 60th day following the end of the year. For the 2015 tax year, the deadline is February 29, 2016.
4. Is There a Good Time to Use the Money in an RRSP Prior to Retirement?
The primary objective of an RRSP is to save for retirement by permitting tax deductions for current period contributions, and tax-deferrals on investment earnings, with the goal of creating a retirement nest egg. Ideally, tax deductions occur during periods of higher income (higher income tax rates) and withdrawals occur during periods of lower income (lower income tax rates). With this in mind, it might sometimes make sense to withdraw funds from your RRSP prior to retirement.
It might make sense to withdraw funds from your RRSP or a spousal RRSP in the first year you become self-employed and your net income is low as a result of start-up costs, or income is deferred as a result of tax planning. For example, if you are commencing a business in 2016, you could contribute $10,000 to your RRSP by February 29, 2016, deduct it on your 2015 tax return, and receive a tax refund. You could then withdraw the $10,000, net of withholding taxes from your RRSP later in the year, include it in your 2016 income, and pay little or no tax as a result of having little or no other income in the year.
That said, since the purpose of an RRSP is to save for retirement, you should think very carefully about the future impact on your retirement wealth before withdrawing funds from your RRSP, especially since RRSP contribution room is finite. (If you plan to re-contribute a previous withdrawal, outside of special programs such as the Home Buyers’ Plan, such re-contributions would utilize future RRSP contribution room.) Also be careful about withdrawing from a spousal RRSP because the income could be attributed to the contributing spouse if a spousal RRSP contribution had been made in the prior three years.
5. Withdrawals from an RRSP
Provided your RRSP is not in a non-redeemable investment or a locked-in RRSP, you may withdraw any portion of your RRSP at any time. In most circumstances, you will pay tax on the amount withdrawn from an RRSP as it is considered income in the year you make the withdrawal. In addition, withdrawals do not affect your RRSP deduction limit; therefore, you will permanently lose that contribution room.
When you make your withdrawal, the financial institution administering your RRSP will withhold 10 to 30 per cent for taxes. You will get a credit for the tax withheld when you complete your income tax return for the year. You might owe additional income tax at that time or be entitled to a tax refund of part or all of the tax withheld, depending on your marginal income tax rate and other income tax withheld for the year.
Funds withdrawn from an RRSP for the Home Buyer’s Plan or the Lifelong Learning Plan are not taxable income in the year withdrawn and are not subject to withholdings. They are, however, subject to repayment or income inclusion requirements over time. Speak to your Chartered Professional Accountant if you are thinking about a withdrawal from your RRSP.
Visit www.rrspandtaxtips.com for more tips from CPABC.
Disclaimer from CPABC: Tax rules relating to these RRSP tips are complex. This is not intended as tax advice and you should not make tax decisions based solely on the information presented in these tips. You should seek the advice of a chartered professional accountant before implementing a tax plan or taking a tax filing position.