How Much Should I Contribute to my RRSP?

by Pam on November 27, 2009

how much should I contribute to my RRSP?

 

 

 

 

We are all becoming more and more aware of the importance of saving for retirement.  Unfortunately, many people have no idea how to go about it.  Some people say it’s best to try to max out your RRSP (Registered Retirement Savings Plan) contribution space each year.  I disagree.  Instead, I recommend contributing enough to take advantage of a lower tax bracket, and then contributing to a TFSA (Tax Free Savings Account) or a non-registered investment account (IA) to supplement additional retirement savings.

I say this because the main advantage of contributing to an RRSP is the tax deduction and the tax-deferred growth.  If contributing $4000.00 in a given year brings you to a lower tax bracket, there is no need to contribute anymore than that since you have already maximized the tax benefits.

On the other hand, that doesn’t mean that you shouldn’t be building up your retirement savings in other ways such as by contributing to your TFSA (up to $5000 of additional contribution space is added each year) and/or contributing to a non-registered investment account.

Once you’ve determined how much you need to contribute to your RRSP, if you still have funds remaining that can be used for retirement savings, I would suggest building up your TFSA, because you don’t have to calculate your capital gains or losses, and more importantly, you don’t have to pay tax on your earnings.  It is also much easier to withdraw from a TFSA if the need arises.

Before deciding on how much to contribute to your RRSP, I would highly recommend checking out  http://www.cra-arc.gc.ca/tx/ndvdls/fq/txrts-eng.html on the Canada Revenue Agency website to see exactly how much you should contribute to maximize your tax benefit.  After that, if you still have room in your budget, consider putting some money into a TFSA and then an IA and set yourself up for success.

For more detailed information on RRSP related topics, check out my RRSP Page.  You can also check out my e-book about RRSPs.

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{ 5 comments… read them below or add one }

Dan September 7, 2012 at 2:35 pm

I would just like to point that the following statement you make in the article is plain wrong: “If contributing $4000.00 in a given year brings you to a lower tax bracket, there is no need to contribute anymore than that since you have already maximized the tax benefits.”

A quick example, using made-up numbers:
- Salary: $84,000
- Marginal tax rate for salary above $80,000: 15%
- Marginal tax rate for salary between $70,000 and $79,999: 10%

A) You buy $4,000 of RRSP:
Your tax saving will be $4,000×15% = $600

B) You buy $10,000 of RRSP:
Your tax saving will be $4,000×15% + ($10,000-$4,000)x10% = $1,200

As you can see, you are in the same tax bracket with options A and B, but you save $600 more by buying more RRSP, as in option B.

Daniel

Pam September 8, 2012 at 9:34 pm

Thanks so much Daniel for pointing this out. You are right. Although most of us either can’t or won’t maximize our RRSP contributions every year, if we can do so we will be further ahead as the tax savings is substantial. However, to be realistic, as most Canadians do not maximize their contributions, it still makes sense for them to contribute some to their RRSP, at least enough to move into a lower tax bracket. I am a huge fan of using my Tax Free Savings Account to save for retirement in combination with my RRSP because I know that I will eventually be taxed on money taken from my RRSP so I never recommend putting all retirement savings into an RRSP.

Craig May 21, 2013 at 2:05 pm

Dan, you’re omitting a crucial point! You still pay the taxes on RRSPs, you just defer paying them until after you retire (or reach age 60).

By starting at such a high salary (far higher than the average taxpayer), you’re confusing the issue.

Say you use the following numbers (closer to the real 2013 tax rates):

- Salary: $50,000
- Marginal tax rate for salary above $45,000: 15%
- Marginal tax rate for salary between $45,000 and $90,000: 20%

A) You buy $5,000 of RRSP:
Your tax saving FOR NOW will be $5,000×22% = $1100

B) You buy $10,000 of RRSP:
Your tax saving FOR NOW will be $5,000×22% + ($10,000-$5,000)x15% = $1,850

BUT… the story doesn’t end there. You STILL have to pay taxes on those “savings”, you just don’t have to do it for a long time.

The only benefit to an RRSP is expecting that you will be in a lower tax bracket when you retire than you are right now. No one can guarantee what tax rates will do in the future, but for this example let’s pretend a) they will be the same as they are right now, and b) when you retire, you’re in the lowest tax bracket based on earnings (15%)

That means:

A) You buy $5,000 of RRSP:
Your initial tax saving will be $5,000×22% = $1100
You retire, collect the money, and are taxed at 15% = $5,000 x 15% = $750
By using the RRSP you have only saved $350 or 7% ($1,100 – $750 = $350)

B) You buy $10,000 of RRSP:
Your INITIAL tax saving was $5,000×22% + ($10,000-$5,000)x15% = $1,850
You retire, collect the money, and are taxed at 15% = $10,000 x 15% = $1,500
By using the RRSP you have STILL only saved $350 or 7% ($1,850 – $1,500 = $350).

So, actually, buying the $10,000 of RRSP did nothing special for you, other than saving some money.

As a final note, your extra $5,000 in example B) will have been earning compound interest which means you are further ahead vs. example A), but it has nothing to do with having that money in an RRSP. A TFSA would have served you just as well.

Pam May 21, 2013 at 10:37 pm

Thanks for sharing, Craig!

Chris June 5, 2013 at 8:57 am

Craig – Your point, namely, that you do not know what will happen in the future, is precisely why it is better to take the guaranteed tax break from your RRSP NOW, rather than wait for some hypothetical tax break in the future, which may or may not happen. Simply put: You do not know what’s going to happen in the future, so take your tax break NOW!

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