RRSP deduction limit has value

Registered Retirement Savings Plans have been around since 1957, allowing investors to sav for their retirement while providing a shelter on tax.

One of the most significant legislation overhauls to RRSP legislation was in 1991 with the carry forward provision.  Now investors no longer have to make a “use it or lose it” decision.

The provision allowed unused RRSP contribution limits after 1990 to be carried forward.  The RRSP deduction limit is included on your Notice of Assessment that Canada Renue Agency sends after you file an income tax return.

Your RRSP deduction limit may be carried forward indefinitely.  This is an important component for everyone to note, considering most people have incomes that increase over time.

Consider Mr. Samson, who is 25 years old and has been a professional student for much of his life.  He decided in 2006 to start working and earned $40,000.  In 2007, Mr. Samson’s RRSP deduction limit is $7,200 ($40,000 x 18 per cent).  Mr. Samson feels that he will be making a larger salary soon and would rather dedicate his current year earnings to paying off his student loans.  He does not lose the $7,200 RRSP deduction limit.  Every year that he does not contribute to an RRSP he will be accumulating a greater deduction limit to be used in the future.  If his income increases then he may save more in taxes by delaying his RRSP contribution.

Marketing by financial institutions may be one reason people rush out and make last minute contributions.  It may also be recent news question whether Canada Pension Plan and Old Age Security will exist when they retire.  Or perhaps it is some internal fear of having enough to live on at retirement that pressures so many into making RRSP mistakes.

Check your Notice of Assessment and your deduction limit before you make any contributions.  You should understand what each line represents.  If you are a member of a defined benefit plan then your statement will have pension adjustments.  If you are a member of a defined contribution plan you should factor in contributions made through work.

The sum of both of these contributions should be factored in prior to making any additional RRSP contributions.  Care should be taken to ensure that you do not contribute over your deduction limit.  Canada Revenue Agency provides a buffer of $2,000 before an excess contribution is subject to tax.

Here’s another illustration to make the point:

For nearly 20 years Mr. Phillip has focused his after tax savings to paying down his mortgage.  At 50, he is proud that he is mortgage free.  Mr. Phillip has managed to accumulate approximately $97,200 of RRSP deduction limit.  Now that he is mortgage free he would like to accelerate his retirement savings but does not know where to begin.  Mr. Phillips annual income is $85,000 and he has been dedicating approximately $1,500 a month towards mortgage payments.  Annually Mr. Phillip’s RRSP contribution room is increasing by approximately $15,300 (18 per cent x $85,000).   We discussed with Mr. Phillips that since he no longer has to make monthly mortgage payments, he should consider making monthly pre-authorized contributions to his RRSP.   We mapped out a plan that he could contribute $1,950 monthly to his RRSP, claim the amount as a deduction and save taxes.  The net amount would likely be close to his previous monthly mortgage payment of $1,500.  Best of all, by age 61, Mr. Phillip should have caught up and fully utilized his RRSP deduction limit.

Contribute Early

Time has an amazing way of compounding investment returns.  Investors who begin contributing early to their RRSP are more likely to be financially prepared for their retirement years.  The sooner people begin investing; the longer the savings will be able to grow on a tax sheltered basis.  Tax deferred compounding over a larger number of years should naturally result in a greater accumulation of funds.  One benefit to waiting later in the year to contribute is the greater certainty you will have regarding your income levels and your actual deduction limit.

Avoid Mistakes

If a person pulls funds out of an RRSP, they do not recover the deduction limit.  This amount is lost.  Clearly understanding that your RRSP deduction limit will not vanish if not used should ease some financial pressures.

An RRSP should generally be set up to fund your retirement and involves a long-term discipline.  If you feel that you will likely have to make a withdrawal then you should consider waiting until you are confident that the funds are committed until retirement.  We would rather see someone miss out on a little bit of time to ensure they are not making the mistakes that some people make.