#AskMelanie: How can I maximize my 2019 RRSP Contribution? Debunking myths.

February… love is in the air and taxes to potentially pay around the corner. How can you save for your retirement and maximize your tax situation? Melanie’s favourite column “The Bean Counter” dives into the myths around your RRSP contribution. We would love to hear if some of these myths have changed your knowledge around your RRSP contributions for the 2019 tax year.

Melanie’s Tip:

Claiming your RRSP contribution

The earlier you contribute to your RRSP the better as it allows for future compounding. However, claiming the contribution as a tax deduction may be more beneficial in the future year rather than in the current year. As part of preparing your personal tax return, I will evaluate the most beneficial timing for claiming the RRSP deduction in order to maximize your return and minimize the overall amount of income tax you pay.

#AskMelanie:

How can I maximize my 2019 RRSP Contribution? Debunking myths.

It’s that time of year again. We have just a few weeks left until the Registered Retirement Savings Plan (RRSP) deadline, and despite its almost 60 years in existence, there are still plenty of myths and misconceptions surrounding this popular retirement savings plan.

Today, Sarah Rahme, CFP, a wealth advisor with BDO Canada LLP, gets us ready for the 2020 RRSP (MARCH 2, 2020) deadline by demystifying 19 common RRSP myths.
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Myth #1: RRSPs are for everyone

The reality is that every Canadian needs to evaluate their own fit for an RRSP. We generally say that Canadians earning a lower income (under $50,000 yearly) should use a Tax Free Savings Account (TFSA) instead. Moderate earners have to weigh the pros and cons before deciding which option will work better for them in the long run. This typically entails weighing the tax savings you would gain today versus the tax cost when you withdraw your RRSP or Registered Retirement Income Fund (RRIF) in the future and how quickly you may need to access the funds in your TFSA.

Myth #2: RRSPs aren’t worth it, since you need to pay tax on withdrawals

Some of you may wonder: what is the point of sheltering tax now since you will be paying it back at some point? Needless to say, should your tax bracket be lower in retirement, you will benefit from significant tax savings and tax-free compounded returns.

But what if your tax rate ends up being higher during retirement? We believe depending upon your specific situation, you may still be ahead based on the long-term tax-free compounding effect.

Myth #3: RRSPs have one use — retirement

An RRSP can also be used for two other key purposes:

purchase your first property through the Home Buyer’s Plan (HBP) (up to $25,000 to purchase your first home)
finance your or your spouse’s training or education with the Lifelong Learning Plan (LLP) ($10,000 per year up to $20,000 in total to finance your education at a qualifying institution).

Myth #4: I should pay off my mortgage and other debt first

Let’s distinguish between two types of debt: high-interest and low-interest. For high-interest debt – the best example is credit cards, which can carry rates of up to 29.99% – absolutely, paying off debt should take precedence. But when it comes to low-interest debt, such as a mortgage, be careful not to scrimp on retirement savings. As long as you can generate a return on your investments that is higher than your cost of borrowing, it may make more sense to invest rather than pay down that low-interest debt.

Myth #5: I cannot make a withdrawal from my RRSP until I retire

Technically, funds in an RRSP are available to the plan holder at any time, even if there is a withholding tax on the funds withdrawn. (The exception, of course, is withdrawals under the Home Buyer’s Plan or Lifelong Learning Plan, which are tax-free.) That being said, unless you really need the money, try to withdraw RRSP money at a time when your tax bracket is the same or lower than it was at the time of the contribution. Be aware that the statutory tax withholding may be significantly less than the actual income tax you owe in April, so plan for this shortfall.

Myth #6: It doesn’t matter when I make my spousal RRSP contribution

This may be the case if you don’t intend to make a withdrawal from the plan in the next three years, but if you do, the contribution timing matters.

As a reminder, spousal RRSPs allow one spouse to contribute to the other’s RRSP. This can often be a sound tax strategy when one spouse earns significantly more money than the other. However, spousal RRSPs come with conditions. One big one is that funds withdrawn within three years are attributed as income to the contributor and taxed accordingly.

Withdrawal rules are based on calendar years, which means that if you make a contribution for 2019 by December 2019, you’ll be able to withdraw money attributed to the plan holder as soon as January 2022. If you make that same contribution sometime in the first 60 days of 2020, you’ll have to wait until January 2023 before withdrawals are taxed in the plan holder’s hands.

Myth #7: I’ll have more money to contribute when I’m older

This is not always the case. It’s true that your student loans will be paid off, and you’ll most likely generate more income. But you may also have new obligations, such as a mortgage or the financial responsibilities of child-rearing.

Myth #8: If I die, the proceeds of my RRSP are subject to taxation

Not always – there are two scenarios:

If the beneficiary of the deceased is a surviving spouse or common-law partner, the funds will roll over tax-free into their RRSP or RRIF.
If you have a child or grandchild who was dependent on you due to physical or mental infirmity, the funds will roll over tax-free into their RRSP or RRIF.

Myth #9: I don’t have enough money to start investing

Like with all investing, the secret formula is compounding. If you begin your investment journey, even with small sums, a long-term strategy will build those initial amounts into greater wealth.

Myth #10: I have to take my deduction in the year I contribute

Well, you can definitely claim your RRSP deduction every year – and benefit from the tax deduction immediately. But remember: If you think your tax bracket will be higher in subsequent years, you may want keep the deduction in your back pocket and maximize your tax savings.

Myth #11: I can only convert my RRSP to a RRIF when I turn 71

It is true that you must convert your holdings by the end of the year in which you turn 71. You can, however, convert a portion, or the entire amount, at any earlier age. In fact, it may make sense to withdraw $2,000 per year from your RRSP to utilize your pension tax credit to offset the taxes on the RRIF income once you turn 65.

Myth #12: Converting my RRSP to a RRIF is my only option when I turn 71

You also have two other options:

take out the account value as a lump sum cash payment. In this case, you’d need to pay tax on the whole payment.
buy a life annuity that would pay income at regular intervals for the rest of your life.

Myth #13: A Spousal RRSP doubles my contributing room

Your personal RRSP contribution limit doesn’t change just because you have two accounts at your disposal. You have a choice to use your own RRSP, your spousal RRSP or a combination of both, but only up to your personal RRSP limit.

Myth #14: I have to use cash to make my RRSP contribution

RRSP contribution rules offer you more ways to contribute than just cash. You can also use stocks and bonds and make what is known as a contribution-in-kind. However, if you transfer stocks or bonds with an unrealized gain, you will trigger a capital gain, and if the stocks or bonds are in a loss position, your capital loss will be denied.

Myth #15: I should borrow money to contribute

Sure, that’s an option. But it’s probably better to make contributions to your RRSP throughout the year. Many people do this via a regular payroll deduction. This both helps your long-term savings and decreases your debt obligations.

Myth #16: I should contribute a lump sum just before the Feb. 28 deadline

Many Canadians do follow that strategy, but it’s suboptimal. First of all, you lose out on a year of tax-free growth for your funds. Besides that, are you convinced you’ll have access to the necessary funds in the waning days of February?

Myth #17: I have to wait until I turn 18 to open an RRSP

This is a common source of confusion. In reality, an RRSP can be opened at any age. A TFSA, on the other hand, can only be opened by someone 18 years or older. That being said, typically it will not make income tax sense to contribute before you are earning substantial income.

Myth #18: I can hold any types of investments in my RRSP

The RRSP rules do restrict some investment vehicles, such as precious metals and land. Some other vehicles are permitted but can be problematic and complex. These include mortgages and shares of a private corporation. Speak with your financial advisor to learn more about holding these vehicles in your RRSP.

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