For most Canadians, the immediate benefit of contributing to their Registered Retirement Savings Plan is obvious: The contribution is deducted from their taxable income.
RRSPs are not a vehicle for tax avoidance however, but tax deferral, says Winnie Go, senior wealth adviser and associate portfolio manager at ScotiaMcLeod, the brokerage division of Scotiabank. The government strictly controls what Canadians can do with their money.
For instance, at the end of the year you turn 71, you must convert your RRSP into a registered retirement income fund (RIF) — which you are taxed on when funds are withdrawn. “The government then requires you to take out a scheduled minimum every year,” Go says.
“The spirit behind it is you’re saving for retirement, so you get a deduction, and when you take the money out, you may be in a lower tax bracket,” she says.
There is a contribution limit of 18 per cent of your previous year’s income, before taxes, up to a maximum of $20,000 for 2008. “So if you earn $200,000, you can’t set aside more than $20,000,” says Go. However, “if you can’t put the whole contribution in, that amount carries forward to future years, so you always have it.”
If you have a pension, a “pension adjustment” based on, but not equal to, your pension is also deducted from your contribution limit.
There are two ways the government allows Canadians to withdraw from their RRSPs without being taxed: One is the first-time homebuyer’s plan, which allows for withdrawals of up to $20,000 toward the purchase of property (a recent federal budget will increase this amount to $25,000).
The second is the lifelong learning plan, which allows Canadians to withdraw $20,000 from their RRSP to help them return to school.
In both cases, borrowers must pay the withdrawals back, “a minimum amount every year over 15 years,” says Go. “Otherwise, it’s taxed as income.”
Even if their withdrawals are not related to postsecondary education or buying a home, Canadians can still borrow money from their RRSP. Go warns against this, as it counts as income and is subject to withholding tax.
“We encourage people to save for their retirement using an RSP,” she says. “There is obviously some flexibility for lifelong learning and first-time homebuyers, and you could use it for a rainy day, but it should be your last resort.”