How Much Should My Client Contribute to Their RRSP?

Figuring out how much to contribute to your RRSP is important. If your client does it right, they can maximize their tax savings now, while setting themselves up for a good income after retirement. If they do it wrong, they could find themselves paying more taxes than they have to.

Luckily, planning how much to contribute to an RRSP isn’t complicated — once your client understands all the moving parts. In this post, we’ll go over everything your client needs to know to plan their RRSP contributions and maximize their tax advantages.

Who can contribute to an RRSP?

Your client can contribute to an RRSP if they:

  • Have earned income
  • Have a social insurance number
  • Filed a tax return
  • Have RRSP contribution room available
  • Are under 71. The end of the year that they turn 71 is their last opportunity to contribute.

The 2021 RRSP contribution & deduction limit

There’s a limit to how much your client can contribute to their RRSP and it changes each year. For the 2021 tax year, they can contribute up to 18% of the earned income they reported for last year’s taxes (2020 tax filing), or $27,830 — whichever is less.

Fortunately, they’re able to beef up their 2021 contributions even after the calendar turns. The deadline to contribute to their RRSP for the 2021 tax year is March 1, 2022.

Remember, even if your client misses the deadline, unused RRSP room carries forward and adds up. If they haven’t maxed out their account in previous years, they should have a considerable amount of space available to them.

How much should your client contribute to their RRSP?

When your client contributes to an RRSP, they’re investing towards a better quality of life for their future self. So if they have money to contribute, it’s almost always a good idea to do so.

Generally speaking, they should aim to contribute at least 10% of their gross income each year to their retirement savings.

If they start contributing in their early 20s, that 10% per year could add up to a sizeable savings and a comfortable retirement. If they start later in life — say, their late 30s — and 10% a year may not cut it.

To see how much money your client can expect in the future from their invested contributions, have them check out this RRSP tax savings calculator.

Find the right number with a financial plan

Keep in mind, these numbers are just general guidelines. Ultimately, the only way for your client to know if they are contributing enough is for them to build a financial plan that accounts for when they plan to retire, all of the different income sources and savings they expect to have, and how much they plan to spend each year. With that information, they can work backwards and figure out whether they’re saving too much or too little.

When your client shouldn’t contribute to an RRSP

There are a few instances when your client may be better off not contributing to their RRSP, and instead putting their money elsewhere. Here are a few examples:

  • If they have high interest debt, such as a credit card balance. Paying down that debt should take priority.
  • If their tax bracket is the same or lower than the tax bracket they’re expecting to be in during retirement. In that case, their money may be better off saved in a TFSA until they’re in a higher tax bracket.
  • If they’re in a lower tax bracket now, but expect it to increase in the short-term. Say they’re expecting a big raise next year, they might want to use a TFSA for the time being.

We have a great article that compares RRSPs vs TFSAs, and when your client should choose one account over the other.

How to figure out your client’s RRSP contribution limit

For your client to see their current RRSP contribution limit, including value carried forward, have them look at their most recent notice of assessment from the Canada Revenue Agency (CRA). They get this notice of assessment after filing their tax return.

They can also view their limit using CRA’s My Account. (If they don’t already have a log in, they should get one – it will make their life much easier come tax time.)

RRSP contributions & pension adjustments

If your client pays into an employer plan such as a pension, that might impact their limit. Their Notice of Assessment from the CRA will show them how their pension adjustment affects their RRSP contribution limit.

Here are some of the ways their employer plan can impact their RRSP limits:

  • Pension adjustments and your client’s RRSP contribution limit: If your client belongs to a pension plan through their employer or union, the amount they can contribute to their RRSP is decreased.
  • If your client has a defined benefit plan, the CRA will estimate the value of the benefit your client earned over the course of the prior year.
  • If your client has a defined contribution or deferred profit sharing plan, the adjustment is the total amount they and their employer contributed during the prior year.

Their Notice of Assessment from the CRA will show them how their pension adjustment affects their RRSP contribution limit.

How to contribute to an RRSP

There are two approaches to planning RRSP contributions: Short term and long term.

With the short-term approach, your client contributes as much to their RRSP as possible every year in order to get the biggest tax deduction they can. This may benefit them now, but in retirement it could cost them.

Once your client turns 71 — or sooner, if they decide — they’ll need to convert their RRSP into a Registered Retirement Income Fund (RRIF). At that point, they’ll be forced to withdraw a minimum amount from their RRIF each year as income. The more money they contribute towards their RRSP today, the more they’ll have to withdraw later.

Keep in mind, if your client’s minimum withdrawal amount ends up being more than they actually need to maintain their lifestyle in retirement, that extra income will put them in a higher tax bracket, so a bigger chunk of their savings will go to taxes.

The long-term approach looks at your client’s needs now, and their needs after retirement. That means figuring out what their living expenses will be after retirement, and saving enough in order to meet them — no more, no less. (For the sake of planning, retirement lasts until you turn 100).

Any savings in excess of that should go into a TFSA. When your client withdraws the money from a TFSA, it won’t be taxed — meaning they’ll remain in a lower tax bracket after retirement.

It’s better not to get overtaxed in the first place. That’s where automatic deposits come in.

Automatic RRSP contributions

The best way for your client to save consistently is to automate deposits to their RRSP on a regular basis, lined up with their payroll. That way, as soon as money comes in, some goes out to savings.

If your client starts making more money, they should make an adjustment to their savings to keep on track. Ask your client to review the amount they’re contributing every couple of years, or when they get a major salary increase.

How I maximize the benefit of my RRSP?

Optimizing RRSP contributions

For most of us, saving too much money for retirement seems like a great problem to have. Still, considering that an RRSP will be taxed on withdrawal, it is possible for your client to save more than they need.

To maximize tax savings over a lifetime, here are a few things that your client should consider:

  • Make sure that your client’s marginal tax rate when they contribute is higher than their average tax rate in retirement. They can find their marginal tax rate here can help them determine the best account type for them.
  • Your client should only save enough in their RRSP to support their lifestyle until age 100 (at the latest).
  • If your client is looking to leave an inheritance for their kids or other loved ones, there may be better ways to do so than through an RRSP, given the taxes. Ask them to consider using a TFSAor non-registered account instead.
  • If your client has saved too much in their RRSP and now their RRIF is providing more income than they need, they should save the extra money coming from their RRIF in a TFSA or non-registered account.

Having your client keep all of this in mind when planning their RRSP contributions will help them get the most out of their money. That way, they’ll pay the least taxes over their lifetime.

Avoid RRSP tax penalties

What happens if your client goes over their RRSP contribution room?

Good news: The CRA gives them a $2,000 cushion for over contributing to their RRSP. So, your client can contribute up to $2,000 over the annual maximum limit without being penalized.

Some people like to intentionally use that $2,000 as “extra space” to contribute more money to their RRSP. We don’t recommend it. Once your client uses up that $2,000 there’s no room for error. Any overpayment will cost them.

The penalty for overpaying an RRSP is 1% per month for any amount exceeding the $2,000 cushion you’re your client overpays by accident, exceeding the $2,000 limit, they need to take the extra assets out of their RRSP as soon as possible. Once they’re withdrawn, the CRA will stop charging a 1% monthly penalty on them.

How to claim an RRSP tax deduction

Reporting an RRSP contribution as a deductible expense is fairly straightforward. If your client is filing taxes online and have linked their tax return to their My CRA account, their 2021 contributions should show up automatically on line 208 of their tax return. Otherwise, their financial institution will send them contribution receipts for any contributions they make before the March 1 deadline. They can add these numbers manually.

Keep in mind your client doesn’t need the actual contribution receipts to file their taxes — they just need to add up the amount they contributed and report the total. Just have them keep the receipts handy for future reference in case they are ever audited.

Deferring RRSP deductions

Your client doesn’t actually have to deduct everything they contributed to their RRSP this year.

Any contributions they don’t deduct this year become “unused contributions”. They carry forward into the following year, when they’ll have the option to deduct them again. They’ll need to report these as unused contributions on their tax return.

Contributed assets will still grow in your client’s RRSP account — they just won’t see any savings for them in the tax year they made them.

Why defer RRSP deductions? Doing so can sometimes help your client maximize their tax savings.

For instance, if your client expects their income to increase in the future, and their tax bracket along with it, waiting to deduct RRSP contributions until that time can help them maximize tax savings.

Similarly, if your client’s tax bracket is lower now than it will be in retirement, they might hold off on making contributions and instead invest through a TFSA.

What to do with a tax return

When your client claims their RRSP contributions, they can expect to get a bigger tax refund. This happens because the government collected too much income tax from them, and now they’re paying back the difference. It isn’t a free paycheque.

RRSPs are just one part of your client’s retirement income

When calculating the right amount to contribute, it’s helpful to consider whether your client can expect to receive additional income in retirement from sources other than their RRSP (which will be converted to a RRIF). Their retirement income may include money from: the Canada Pension Plan (CPP), any other pension plans they are a member of, Old Age Security (OAS), and any businesses they may be running post-retirement.

Let’s say they’re getting retirement income from their RRSP, as well as CPP and OAS payments. And they’re also selling vintage 2021s fashion on Etsy. Their income each year will look like this:

Example

RRIF + OAS + CPP + Etsy = Retirement Income

Suppose your client’s Etsy store does really well — today’s young people are crazy about the clothes their grandparents wore back in the 2010s. It could be the case that their income adds up to an even bigger paycheque than they were earning before they retired, pushing them back into a higher tax bracket. Suddenly, their tax savings are nil.

For a similar article on RRSP by CI Direct Investing, read What Is an RRSP and How Does It Work? and When’s the RRSP Contribution Deadline? Key Dates You Need to Know. Also, be sure to share the client-friendly version of these articles with your clients because knowledge is key!

For more information on the many benefits of RRSPS, contact PPI’s Wealth Management team.

Reposted with permission from CI Direct Investing.

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