A Registered Retirement Savings Plan (RRSP) can represent a key source of future retirement income for many people in Canada. However, contributions to your RRSP and the tax savings gained are only the first steps toward enhancing your contributions' growth. These strategies can help maximize your RRSP savings:
1. Contributing early
The majority of Canadians make their RRSP contributions at the end of the tax year. By either making your contribution at the beginning of the tax year or making regular monthly contributions, you'll build a significantly larger RRSP. This is due to the additional years of compound growth that come from making your contribution sooner rather than later, i.e., the earlier in the year you move your money into an RRSP, the sooner it will start growing and working for you.
2. Investing in a spousal RRSP
Splitting RRSP income with your spouse or partner—known as income splitting—is one of the most effective methods to reduce taxes. The objective is to provide both spouses with similar incomes—and similar income tax rates—in retirement. Before setting up a spousal RRSP, a couple should estimate their expected retirement incomes. If one spouse is likely to have a significantly lower retirement income, then spousal RRSP contributions may provide valuable options.
In a spousal RRSP, the higher-income-earning spouse will typically deposit the contribution in the other spouse's RRSP and claim the contribution on their tax return. Essentially, these types of RRSPs help build your spouse's retirement savings and potentially lower the amount of tax that you pay collectively.
3. Borrowing to make an RRSP contribution
While borrowing to invest outside your RRSP may provide you with a tax-deductible interest expense, borrowing to make an RRSP contribution will not. This is further complicated when you can carry forward your unused contribution limit and invest that available cash in a future year. Carrying forward your contribution will avoid borrowing costs and tax-deferred growth would be forfeited. In general, if you plan to repay an RRSP loan within one year, this strategy should prove advantageous. Use your tax savings from the contribution to help repay your RRSP loan.
4. Timing your RRSP deduction
While it's advisable to make your RRSP contribution each year, you can choose to delay claiming the tax deduction until a future tax year. If your income tends to fluctuate from year to year, consider timing and deferring the tax deduction to a future year when your income, and therefore your tax rate, will be significantly higher. While this strategy delays the tax savings, your contribution is growing tax deferred.
To illustrate the benefit of this strategy, let's assume your current marginal tax rate is 25 percent, but you expect your income will rise next year, increasing your tax rate to 40 percent. If you made a $10,000 contribution this year and claimed the deduction, you will save $2,500 in taxes, while waiting until next year would yield a $4,000 tax saving.
5. Setting a target
If you're like many Canadians, you strive to save as much as possible within your RRSP each year. The question is, "Will it be enough?" Before you can answer this question, you need to determine your desired retirement lifestyle. Figuring this out in advance will allow you to set a savings target for your RRSP. Establishing this target allows you to gauge your progress and determine when enough is truly enough.
As a general guide, for every $10,000 in before-tax retirement income, you should accumulate $150,000 in RRSP assets by the year you retire.
Bear in mind that this strategy assumes your life expectancy post-retirement is 25 years, your pre-retirement income increases at a rate of three percent per year (in line with inflation) and an eight percent growth rate on your investments.
The strategies, advice and technical content in this publication are provided for the general information only and benefit of our clients. This publication is not intended to provide specific financial, investment, tax, legal, accounting or other advice for you, and should not be relied upon in that regard. Readers should consult their own professional advisor when planning to implement a strategy to ensure that individual circumstances have been considered properly and it is based on the latest available information.
In Quebec, financial planning services are provided by RBC Wealth Management Financial Services Inc. which is licensed as a financial services firm in that province. In the rest of Canada, financial planning services are available through RBC Dominion Securities Inc.