To have RRSPs, or not to have, that is the question.
We’re in RRSP “season”, as 2017 contribution deadlines approach and many of us know we can use RRSPs for tax credits. But do we know exactly how RRSPs work?
When I ask small business owners why they have RRSPs, the most common responses are either “Someone told me I should” or “I want the tax break”. While it’s great to have the credits up front, we should also consider what happens in the long term when we take the money out.
Let’s start with RRSP basics.
WHAT IS AN RRSP?
An RRSP (Registered Retirement Savings Plan) is an account we can use to save and invest money for retirement. Since it’s a registered plan, all contributions and growth are monitored by the federal government based on our Social Insurance Number.
It’s important to note that the RRSP itself is not an investment, it’s simply a “container” that holds investments and these investments must adhere to the rules of the program.
HOW DOES IT WORK?
The idea behind the RRSP is that we invest our money in a tax deferred environment, so we have the advantage of higher compounding growth while the money is in the plan. When we are ready to use the money, we pay income tax on the withdrawals.
- Can I open an RRSP?
To be eligible for an RRSP, you must be a Canadian resident for tax purposes, be under the age of 71 and must have contribution room.
- What is my contribution room?
You can contribute 18% of your previous year’s income, up to a maximum dollar limit, plus any unused room from previous years.
Your 2017 contribution room will be calculated as 18% of income earned in 2016, up to a maximum of $26,010. You can get your total contribution room from your last CRA Notice of Assessment. All 2017 RRSP contributions must be made before March 1st, 2018.
- What can I invest in?
GICs (Guaranteed Investment Certificates) and Mutual Funds are used by many Canadians. Stocks and real estate can also be used.
It’s important to note that your investments should be based on your personal risk tolerance and investment objectives and speaking to an advisor is a great way to make sure you are using a strategy that works for you.
How long can I contribute for?
You can continue contributing to an RRSP until December 31st of the year you turn 71. After that, you can
- withdraw all the money and pay withholding taxes on the full amount.
- purchase an annuity. There are no withholding taxes on purchasing the annuity, but you pay taxes on the income you receive from it.
- convert the RRSP into a RRIF (Registered Retirement Income Fund). There are no withholding taxes on conversion, but you will pay taxes on the income you receive. Once your RRSP has been converted into a RRIF, the government will give you a schedule of the minimum amount you must withdraw per year.
What are some other features of the RRSP?
- Spousal RRSP: if you have a spouse in a lower tax bracket and you are in a higher tax bracket, you can contribute to your spouse’s RRSP and have the tax credit go to you
- Home Buyer’s Plan (HBP): You can borrow up to $25,000 tax-free from your RRSP to buy your first home. This must be paid back into the RRSP over 15 years, otherwise you’ll end up paying the taxes as if it were a regular withdrawal.
- Lifelong Learning Plan (LLP): You can also borrow up to $20,000 to pay for your education but this must be paid back into the RRSP over 10 years.
WHO IS IT RIGHT FOR?
RRSP features can provide many benefits, but these may not necessarily benefit business owners in the long-term.
If your income during your working years will higher than your retirement income, contributing to an RRSP may be a good idea so that when you withdraw the money during retirement, you will be in a lower tax bracket and will likely pay less taxes (e.g. doctors, lawyers and other high-salaried employees).
If you are in a lower tax bracket in your younger years and expect to be earning a higher income during retirement, an RRSP may not be the best thing. As a business owner, this is usually the case – you are in a lower tax bracket in your younger years while you are building your business. As your business expands and becomes more successful, you are likely to have higher income in your retirement years and any withdrawals from an RRSP will be added on as extra income, therefore putting you in a much higher tax bracket.
Of course, there is no quick rule in determining whether to use RRSPs or not. The structure of your business (sole proprietorship, partnership or corporation) plays a major role in how you receive income, and as such it may take some detailed business planning with your lawyer, accountant and financial advisor to figure out the best route for you. It really boils down to the question “Do I want to pay the taxes now, or later?”.
Another option to consider investing your money is a TFSA (Tax Free Savings Account), which I will cover in another article.
To learn more about RRSPs: https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/rrsps-related-plans.html
Kim Lowrie is an insurance agent and mutual fund representative with World Financial Group.
She and her husband have made it their lifelong mission to help families, individuals and business owners succeed financially.
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