A guide to making RRSP contributions

A Registered Retirement Savings Plan (RRSP) is a great way to save for your retirement. But did you know there are several ways of contributing to this investment vehicle?

Here some things to consider when contributing to your RRSP:

Earned income

Contribution limits to your RRSP are, in part, based on a percentage of your “earned income” from the previous year. What qualifies as earned income? Here are some examples:

• Salary or wages from employment. Deductible employment-related expenses such as union or professional dues reduce this amount.
• Disability pensions paid under the Canada Pension Plan (CPP) or Quebec Pension Plan (QPP) (you must reside in Canada when you receive the payments), and taxable income from a disability plan. Regular CPP and QPP retirement pensions do not qualify as earned income.
• Net income from a business owned or operated by a self-employed individual or an active partner of a partnership.
• Net rental income from real property.
• Payments from supplementary unemployment benefit plans (not Employment Insurance).
• Taxable alimony or maintenance payments received.
• Royalties and net research grants.

Your earned income should be reduced by the following amounts if any of these situations apply:

• Losses from a business owned or operated by a self-employed individual or an active partner of a partnership.
• Net rental losses from real property.
• Deductible alimony or maintenance payments.

Contribution limits

The annual RRSP contribution limit depends on your earned income from the prior year and, if applicable, the deemed pension benefit (from your employer pension plan) from the prior year.

Here’s a two-step calculation to determine your current RRSP contribution limit:

1. Determine your overall limit. This is calculated as the lesser of 18 percent of your earned income or that year’s maximum RRSP deduction limit, which you can find on the Government of Canada website .
2. Subtract your pension adjustment (PA) factor, if applicable, from the prior year.

Use these formulas above to calculate your overall limit—this will be the amount reduced if you’re a pension plan member. If you’re not a member of a pension plan or a deferred profit-sharing plan (DPSP), your overall limit calculated in step one represents your actual contribution limit for the year.

The carry-forward rule

Individuals who don’t contribute their maximum annual contribution to their RRSP can carry forward the “unused portion” in a future year. This unused portion may be carried forward indefinitely.

Be aware, however, that waiting until a future year to “catch up” on deductible contribution room will, in most cases, result in a smaller RRSP due to the loss of tax-deferred growth.

Excess contributions

As long as you don’t exceed your available contribution limit by more than $2,000 on a cumulative basis, a penalty tax of one percent per month on the excess amount is not assessed.

If a contribution exceeds the $2,000 excess contribution limit, it will incur a penalty tax if it’s not removed. The excess amount is taxable income unless it’s withdrawn in the year that it’s contributed—the year the Canada Revenue Agency (CRA) Notice of Assessment is received, or the following year.

Note: The $2,000 excess contribution limit is available only to individuals who turned 18 in a prior year.

Contributions made by securities

If you don’t have the cash to make an RRSP contribution, you can contribute eligible investments from outside your RRSP at their fair market value. For tax purposes, investments transferred into the RRSP (i.e., an in-kind contribution) are treated as if the investment was actually sold. Therefore, this transfer triggers a taxable capital gain.

Unfortunately, if the fair market value of the transferred investment is less than its original cost, the capital loss cannot be claimed. Also, any accrued interest up to the transfer date must be reported as income (i.e., the interest that has been earned but not paid).

Transfers into an RRSP

Certain amounts may also be transferred into your RRSP in addition to your allowable RRSP contribution limit. These lump-sum transfers are allowed between registered plans on a tax-deferred basis. They include:

• Retiring allowances (a lump-sum payment in the form of a retirement or severance package).
• Lump-sum transfers from a pension plan.
• Transfers from another RRSP.

Before contributing to retirement savings accounts, make sure you understand your options.