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Should I make an RRSP contribution?

RRSPHave you made your RRSP contribution yet?  Or does the thought of even looking at it make you want to crawl under a rock?  A reader asked the question of whether getting an RRSP loan is a good idea, so I will address that in this post, but first we need to take a step back and consider whether making an RRSP contribution is a good idea at all.  While answering this question definitively in a blog post is impossible, we will at least discuss some of the factors to consider.

Does your employer have a matching program?

If your employer has any kind of RRSP matching program and you choose not to participate, you’re just flushing money down the toilet.  Usually, if you don’t make the contribution during the year, you’re out of luck – retroactive matching is rare.  Find out whether this type of program exists where you work.  If it does, chances are you should join and make that your first priority with your money.  Contribute at least enough to generate the maximum matching amount.  They are offering you free money – take it!

Assess the tax deferral benefit for you

If your employer doesn’t have a matching program, or you’re trying to figure out whether to contribute an extra amount to the plan, the next step is to figure out what your potential tax savings would be if you make a contribution.  There are 2 ways to do this – the simple way and the more accurate way.

The simple way

This method can give you a ballpark amount to work with.  If you know approximately how much your income was in 2012, go to this link and click on the province where you live.  Find your income on the chart labelled Combined Federal & Provincial Tax Rates Including Surtaxes (use the 2012 chart, not 2013), and look under the column called “other income”.  The percentage rate that you see there is your marginal tax rate.  This is how much you would reduce your taxes payable by making an RRSP contribution.  For example, if your income is $50,000 in Ontario, and you made an RRSP contribution of $1,000, you would save 31.15% of the contribution – $311.15.  If you earned $43,000 in Saskatchewan and made a contribution of $1,000, you would save $299.21 – that being $293 x 35% + 642 x 28% + 65 x 26%.  Ok, so perhaps the Saskatchewan example isn’t exactly “simple”, but you get the idea.

The simple method won’t take into account all of your other deductions and tax credits and therefore won’t be completely accurate.  However, if it’s the eleventh hour and you don’t have time to calculate everything, at least it will give you a general idea.

The more accurate way

The more accurate way is to actually input estimates into your tax software and then look at your tax refund/balance owing without an RRSP contribution and then with an RRSP contribution.  Use your T4 or your final pay stub from 2012 as your income.  Ideally, you’d have all your other tax documents, but those may not be ready yet.  As a minimum, you need to know the approximate amount of your larger deductions.  Your estimate is not going to be exact, but you should at least be able to figure out what tax bracket you’re in.

After you’ve input your basic income & deduction numbers, take note of where you’re at.  Then, put in an RRSP contribution as if you had made it and see what the difference is in your refund/balance owing.

Don’t forget about other benefits

Many government benefits are calculated using the net income line of your tax return (line #236).  If you make an RRSP contribution, you will reduce this number, increasing your benefit.  Tax software doesn’t usually calculate these numbers for you.  Canada Revenue Agency has calculators at this link that you can use to estimate these amounts.

Other factors to consider

In addition to the value of the tax deferral, how close you are to retirement is another factor to consider.  If you’re just starting out in your career, having the money growing tax free for decades is going to be more valuable than it would be for someone who is going to retire in a few years.

Knowing approximately what your income is going to be in retirement is also important.  I had a client a few years ago who left the paid work force to be at home with her children.  A few years later, she generated some one-time income and had planned on making an RRSP contribution with the money.  I ran the numbers for her and she was going to save about 20% in tax by putting the money into her RRSP.  Her husband was only a few years away from retirement at this point and once he stopped working, they were both going to be withdrawing from RRSP’s fairly evenly.  Her tax rate when he retired was going up to about 35-40%.  In this case, it did not make sense to put the money in at 20% savings only to take it out in 5 years at a tax rate of 35%.  Your tax rate in retirement should not be ignored.

I’ve decided I want to contribute – should I get a loan?

You’d have to give me a pretty compelling reason for me to say yes to this question.  Instead of getting a loan now and making payments for the next year or two, why not just take what you would have paid in loan payments and put that money directly into your RRSP?  Yes, it’s true that you’re not going to get an immediate tax refund like you would if you got the loan, but at least you won’t be starting out each year behind the eight ball.  If you spend all of 2013 repaying 2012’s loan, then you’ll need another in 2014 to make 2013’s contribution.  Who stands to benefit the most from this black hole?  The bank!

Instead, when your refund arrives in the spring, even if it’s a small amount, put that right into your RRSP for 2013.  Try to set aside an amount every pay and have it go automatically into your RRSP.  Even if it’s just $25 every other week to start, that’s $650 more than you would have otherwise.  Every little bit helps!

Will you make an RRSP contribution this year?

February 1, 2013

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