Tax Deferral
While it’s nice to get the refund for making an RRSP contribution, the primary reason is to defer income tax until your retirement. I have heard on several occasions that some people have commented, to my clients, they wished they had never contributed to an RRSP because now in retirement they are being taxed on the withdrawals. While this is true, many people forget that this tax is at your marginal tax rate (the tax you pay on the next dollar earned) and it’s probably much lower in retirement than in your working years. The Canadian tax system is a progressive system i.e. the higher your taxable income the higher percentage of income tax you pay!
Here’s an example.
If your taxable income was $52,000 in 2005 then your marginal tax rate is just over 31%.
If your taxable income was $26,000 in 2005 then your marginal tax rate is just over 22%.
Please consult Canada Revenue Agency, CRA for your individual circumstance.
If we make a basic assumption that in your working years, you were in the 31% bracket and in your retirement years you were in the 22% bracket, your net tax savings in 9%. Yes, you still paid taxes but at a much lower rate! Here are a couple more strategies to consider.
What do you do with your tax refund?
Financial planners typically recommend you reinvest the refund back into the RRSP for next year’s contribution, into your children’s RESP or possibly make an extra payment on your mortgage. These are options that help increase your net worth and reach your financial goals faster; however, even if you spend the money on a trip or buy something somewhat frivolous, you have still come out ahead because you haven’t spent your regular income to purchase the item. Maybe you should consider half for the RRSP and half for fun.
Spousal RRSPs
If you expect you or your spouse to be in a higher tax bracket in retirement then the spousal RRSP is one of the most effective methods for income-splitting. Using the example above this tactic can be used to illustrate. It is more tax efficient for a couple to earn $26,000 each than if one earns the entire $52,000.
Pay Yourself First
One of the easiest ways to get that RRSP working for you is to set up a monthly savings plan. If you don’t see it, you won’t miss it. Enough said on that subject.
New RRSP Limit for 2006
The RRSP limit has been raised to a maximum of $18,000 (or 18% of 2005 earned income whichever is less) for 2006.
Take control of your RRSP for a successful 2006. Maybe it’s time for a financial plan!
For more information, please contact me at 966 8289 or email: dmaycock@a-q.com. Visit www.donmaycock.com and subscribe to “The MAYCOCK Letter” for valuable financial planning information.