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By Allan Small
Special to the Financial Independence Hub
If there is one thing COVID-19 has not impacted, it’s RRSP season. March 1, 2021 is the deadline for contributing to an RRSP for the 2020 tax year. The question is, should you?
The basics: Anyone who files an income tax return can contribute 18% of earned income to a maximum of $27,230 for the 2020 tax year. If you have an employer-sponsored pension plan, your RRSP contribution limit is reduced by the Pension Adjustment (PA). Unused contribution room can be carried forward to use in the future.
Generally speaking, RRSPs make sense for anyone who wants and can afford to invest for the long term. Here’s why:
Pros
- Contributions are tax deductible.
- Earnings grow tax-sheltered within the plan.
- You can defer tax on investment earnings and contributions to the future. This is particularly useful if you are a high-income earner and your marginal tax rate is likely to be lower in the coming years.
- RRSPs can hold a wide range of qualified investments. For example, you can hold GICs, savings bonds, Treasury bills, bonds, mutual funds, Exchange Traded Funds (ETFs), equities (both Canadian and foreign), and income trusts in an RRSP.
Deciding what to hold in your RRSP really comes down to the same factors you have to consider when making any type of investment: your comfort level with risk, your investment objectives and your time horizon. For example, if your goal is to grow your wealth over time and market volatility doesn’t keep you up at night, then you may want to consider growth investments such ETFs, mutual funds and stocks. If you want income, then income-generating and interest-paying investments are worth looking into.
All of this said, RRSPs do have their drawbacks.
Cons
- While you can withdraw funds from an RRSP before you retire, you will have to pay a withholding tax and you also have to report that money as taxable income to the Canada Revenue Agency.
- The Government of Canada controls the amount of money that must be withdrawn annually once the RRSP matures. When you convert the RRSP to an Registered Retirement Income Fund, which must be done when you turn 71, you are required to withdraw a minimum amount each year starting at age 72 even if you don’t need the money.
RRSPs work best for people who can use a tax deduction and can afford to put money away for the future. Another consideration: Is your income in retirement (and therefore the marginal tax rate you’ll have to pay) going to be equal to or greater than it is during the years you can contribute to an RRSP? If this is the case, you won’t be achieving any tax savings by contributing to an RRSP. However, you could still benefit from deferring tax. The question then becomes, do you pay the income tax now or later?
If you don’t need a tax deduction and want more flexibility, then investing in a Tax Free Savings Account (TFSA) is a good option. You still enjoy the benefits of tax-free growth and the ability to hold a wide range of non-registered investments plus you can take money out anytime without triggering income tax.
However, if you do withdraw funds, you have to wait until the following year to recontribute that amount, at which point you can also make the annual maximum contribution of $6,000. If you contribute too much to your TFSA, you’ll pay a penalty of 1% per month on the excess amount until you remove it. The total contribution limit for TFSAs since their inception in 2009 sits at $75,500.
RRSPs and TFSAs are the only way to invest and not pay tax on the growth of your investments. It’s not an either-or situation. You should consider both as part of your retirement saving strategy.
Allan Small is the Senior Investment Advisor at the Allan Small Financial Group with iA Private Wealth Inc. (www.allansmall.com) as well as the author of How To Profit When Investors are Scared.
This information has been prepared by Allan Small, who is an Investment Advisor for iA Private Wealth Inc. and does not necessarily reflect the opinion of iA Private Wealth. iA Private Wealth Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. iA Private Wealth is a trademark and a business name under which iA Private Wealth Inc. operates.
