RRSP's - What? When? How Much?

Well here it is, 2006, and it’s time to start thinking about your income tax again. As usual, the first item up is the RRSP contribution. For those that have made a monthly contribution, good for you. Your investment will be worth more in the end than the people who only contribute once a year. However, you may want to have a look at topping up your contribution before the deadline. For the people that wait until the last minute, you have until March 1st to get it done.

Here are a few of the basics:

• money that you contribute to a Registered Retirement Savings Plan is deducted from your income before the amount of tax that you owe is calculated.

• you may contribute a maximum of 18% of your 2004 earned income to a maximum of $16,500 plus any unused contribution eligibility from 1991. (check your 2004 Notice of Assessment for the correct amount or you can call Canada Revenue Agency's T.I.P.S. line for more information). The CRA web site is in our links at the side of this page.
  

• prior to this year, you were restricted as to the amount of foreign content in your RRSP but this restriction has been lifted.

If you wish to calculate the amount you can contribute yourself, as well as find out just what qualifies as “earned income”, you can download the entire CRA (Revenue Canada) guide on pensions. You can either go to the Services page on our web site or:

click here to get it.



How Much To Contribute

Remember that you are buying an RRSP for two reasons. The primary reason is to save money for your retirement. Once purchased, your investment and it’s growth are sheltered from any income tax until it is withdrawn. Under this reason, you should probably contribute whatever you can afford. Building your “nest egg” is always a good idea. You should also try to make a monthly, rather than annual, contribution. This gives you the advantage of buying into the market at different levels plus it is easier to save it a bit at a time rather than in one big lump.

As to what to buy, I will try to cover the advantages and disadvantages of different types of investments in a separate article in the future.

The secondary reason (although for some people, the primary reason) for buying an RRSP is the tax savings. The idea is that when you take it out, you will be in a lower tax bracket than you are now. But just how much you save will depend on how much you have earned during the year.

The best tax savings are made when your income is high. Let’s examine the 2005 federal income tax rates. Provincial rate vary from province to province so I can only use the federal rates as a guide.

The first tax rate increase happens on taxable income over $35,595. The federal tax rate rises from 15% to 22% on amounts over the first $35,595. If you estimate that the provincial tax is about 50% or less of the federal amount so for the sake of this discussion, lets say that it’s 10%. Your contribution target should be to eliminate or lower any income above $35,595. At our estimated tax rate, every $1,000 that you contribute will save you $320. Naturally, if your income is higher, you will save even more. The next tax level is $71,190. Income tax on amounts over that is 26%. The provincial rates rise to about 12% so now you save $380 on every $1,000 contributed.

I won’t bother going beyond this right now, but as you can see, eliminating tax on the higher brackets is the best strategy.

In my next article, I will be discussing types on investments and the reason for spousal RRSP. Please check back and go to our web site for more information.