January 29, 2021 by David Christianson
Well folks, it’s that time of year again.
No, I don’t mean the one-year anniversary of COVID-19 reaching our shores, or my own milestone birthday next week, but rather the annual ritual we sometimes call “RRSP Season”.
However, this year will be unique, as I (and actual knowledgeable people) am predicting a record amount of RRSP contributions this year. This is based on the record-setting (and I mean by warp factors) higher savings rates in 2020.
That’s right – spendthrift Canadians, who had a declining savings rate for decades, put away massive amounts into cash reserves in 2020.
It’s sadly ironic, as we all know people whose finances crumbled in 2020 due to job loss, business closings, and other negative effects of the pandemic.
But those who kept their jobs and saved the money they might’ve spent on travel, entertainment, eating out and other historic indulgences, have instead paid off lines of credit and built up record amounts of short-term savings.
The other irony is that the interest rate being paid on those savings is now pretty much zilch. So, the improvement in people’s financial situation is great news, but now those resources need to be utilized for maximum benefit.
And that brings us back to how to invest that new-found money. For anyone with high interest rate debt, like credit cards that don’t get paid off each month, that’s the first target for that money.
People who are employed and in the middle or high tax bracket should seriously consider making (and perhaps maximizing) an RRSP contribution before the March 1 deadline.
That deadline applies to contributions that are deductible against taxable income on your 2020 income tax return. Since the RRSP deposit reduces taxable income, it saves you tax at your marginal tax rate.
If your taxable income in Manitoba is between $48,535 and $72,164, for example, your marginal tax rate is 33.25%. (That includes federal and Manitoba tax.) That is the rate you paid on your last dollar of income from employment, self-employment or interest income, and that is the rate at which you will save taxes with an RRSP contribution.
If your MTR is 33.25%, then every $1,000 contributed to your (or your spouse’s) RRSP will reduce your taxes by $332.
If you are studious and use that $332 as an additional contribution for next year, you will increase your affordable savings rate, while also reducing your taxes for next year.
The interest, dividends and capital gains earned within your RRSP are tax deferred. Any withdrawals from the RRSP in the future adds to your taxable income.
That tax deferral is worth a lot, especially if it defers tax for 10, 20 or 30 years. Even better, the real magic occurs if your tax bracket is higher while you are working (or because of a one-time capital gain or other windfall) and you are in a lower tax bracket at some point in the future, when you withdraw, to provide yourself with retirement income.
An RRSP contribution also decreases your “net” income. For high income earners 65 and older, this could reduce the clawback of Old Age Security.
Your 2020 RRSP limit is found on your 2019 Notice of Assessment, sent to you from CRA after you filed your 2019 return. It is calculated at 18% of your earned income, to a 2020 maximum of $29,210.
There are many online calculators (like TaxTips.ca) to help you determine your marginal tax rate. Take a look and see how much money you can still save on your 2020 taxes.
Once you’ve made a contribution, then the next step is investing it wisely for the long-term. That’s what will really get you ahead.
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Dollars and Sense is meant as an introduction to this topic and should not in any way be construed as a replacement for personalized professional advice.
Please consult legal, tax, insurance and investment experts for advice on your unique situation.
David Christianson, BA, CFP, R.F.P., TEP, CIM is recipient of the FP Canada™ Fellow (FCFP) Distinction, and repeatedly named a Top 50 Financial Advisor in Canada. He is a Senior Wealth Advisor & Portfolio Manager with Christianson Wealth Advisors at National Bank Financial Wealth Management, and author of the book Managing the Bull, A No-Nonsense Guide to Personal Finance.