Should I Contribute To My RRSP This Year?

by Pam on January 20, 2011

Canadians have until March 1st to make an RRSP contribution towards their Registered Retirement Savings Plan (RRSP) in order to take advantage of a tax deduction for the 2010 tax year.

Before you make this important decision, be sure to consider a few things:

Do you have the ability within your budget to make a contribution?

If you haven’t been contributing regularly all year, have you set enough money aside in order to make a lump sum contribution?

If you will be dipping into your emergency funds in order to make your contribution or you will be left just scraping by, then perhaps it is wise to just hold off in making any contributions this year.  Why?  Because if you are depending on your RRSPs as a back up emergency fund then there is no point in putting money into an RRSP in the first place.  There are just too many tax penalties and negative implications for making an RRSP withdrawal.

Instead, if you can afford to, consider setting up a small preauthorized contribution towards your RRSP and contribute a little every payday or every month.   Then it will be less painful than trying to come up with a lump sum every year.

If on the other hand, you do have sufficient funds available and are considering an RRSP contribution, then the following tips will be important:

What is your RRSP Contribution Limit?

First it is important to determine how much of an RRSP contribution you are allowed to make.  Every year when you file your taxes, the government issues you a Notice of Assessment that will tell you what your RRSP contribution limit is for the following year. You do not want to overcontribute as there are penalties, so it is important to stay within your limit.

How much should I contribute to my RRSP?

Your second step is to determine how much of a contribution you should be making in order to maximize your tax savings for 2010.  You can find out the perfect number for you by contacting your accountant who can do the number crunching for you.

If you would prefer to do your own number crunching, first check out this tax website to determine the 2010 federal and provincial income tax rates.  Your goal is to contribute enough to get below the tax bracket.  For example, if you live in Alberta and you have a gross annual income of $45,000, you will want to contribute at least $4030.00 in order to reduce your taxes by 7%.

You can also use a personal tax calculator to help you determine the impact of an RRSP contribution.  Simply input your gross annual income at the top and then look at your particular province’s total tax payable.  Next, adjust your gross annual income by the amount you want to contribute to your RRSP.  Pay attention to the new dollar amount for the total taxes payable.  Subtract the two figures and you will get an idea as to how much of a refund you can expect.

For instance, if you live in Ontario and have a gross annual income of $60,000, your taxes payable is $12.292.  If you decide to make a $5000 contribution to your RRSP, then your gross annual income drops down to $55,000.  Now your taxes payable is down to $10,734, which means you will be saving approximately $1558 in taxes.  This is an easy way to try different contribution amounts and see just how much of a refund you can expect based on each figure.

Is All Of My Retirement Savings In RRSPs?

One final thing to consider before making your RRSP contribution is whether or not your entire retirement savings should be saved within an RRSP.  With the introduction of the Tax Free Savings Account (TFSA) in 2009, you may want to talk to your accountant about the benefits of using a TFSA as a retirement savings vehicle in addition to an RRSP or perhaps instead of an RRSP.  While it is true that making an RRSP contribution does get you a tax deduction now, you have to remember that when you start to use the money within your RRSP, you will be taxed on the funds withdrawn and the amount of tax you pay will depend upon your taxable income at that time.  For some, withdrawing from an RRSP can result in Old Age Security clawbacks.  In other words, if your income is too high you may lose some or all Old Age Security benefits.

Also, for those of you who are already in the lowest tax bracket, you will likely benefit more from saving for your retirement within a TFSA instead of an RRSP because the tax savings is minimal as you are already paying the least amount of tax.

Once you have figured out how much to contribute, get in touch with your financial institution and make your contribution.  As well, talk to your financial institution about starting up a regular automatic contribution starting now for 2011 so that you can get a head start on taking advantage of tax deferred growth and then you will only have to top up your contributions next year instead of coming up with the whole lump sum all at once.  The sooner you get the money into your RRSP the sooner it can work towards your retirement savings goals.  Why wait until the deadline?

For more information on RRSPs, check out my RRSP Page.

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