Registered retirement savings plans are one of the last minute tax planning strategies that most Canadians can take advantage of. That is because the period for making contributions in any given tax year ends 60 days after the end of the calendar year. That being said, there are some instances where your RRSP tax strategy needs to be considered before December 31.
Understanding RRSPs
RRSPs allow you to contribute money to your savings while also recognizing tax savings.
Each year, you have a contribution limit – in 2020 this limit is equal to 18% of your 2019 income up to a maximum of $27,230. Any unused contribution space from previous years is carried forward indefinitely.
When you contribute to your RRSP, the amount is deducted from your taxable income, dollar for dollar. This means you don’t have to pay tax on the contributed income in the applicable year.
Any amount you withdraw in the future, including interest earned (investment income), will be taxed at the applicable rate. With proper planning, it should be taxed at a rate equal to or lesser than the rate you would have paid in the year of contribution, had the contribution not been made.
It’s important to note that once an amount is withdrawn, you permanently lose the contribution room, with some exceptions, i.e. the Home Buyer’s Plan.
RRSPs for Those Who Turned 71 This Year
Canadians are able to make contributions to our RRSPs until the end of the year in which we turn 71. Once that year is over, the RRSP must be collapsed into either a Registered Retirement Income Fund (RRIF), an annuity or cash.
If you turned 71 this year (or will be turning 71 by December 31st), you will not be able to take advantage of the 60-day extended contribution window after December 31st. Therefore, if you are 71 this year, you need to make your contributions before year-end.
Making Spousal RRSP Contributions
Another benefit of RRSPs is that you can make contributions in your spouse’s name and deduct the contribution on your own tax return. This reduced your current year taxable income.
When the money is withdrawn by your spouse, the amounts are taxed on your spouse’s return. The intent being that your spouse has a lower income and will therefore be able to withdraw the amount at a lower rate. This can be a great tool for families with a spouse in a higher income tax bracket.
There are some rules specific to spousal RRSP contributions that need to be considered. Specifically, withdrawals of spousal contributions will only be taxed at your spouse's rate if they’re withdrawn no sooner than the end of the second calendar year after the contributions were made.
Example:
If you contribute on behalf of your spouse in 2020, a withdrawal would only be taxable in their hands if they withdraw the funds no earlier than January 1, 2023. If you wait until the 60-day contribution window, ending March 1 of 2021 to make the same contribution, you will have to wait until 2024.
Taking advantage of this tax strategy is important for unexpected withdrawals on rainy days or for anybody planning to withdraw contributions made on behalf of their spouse in the near future, as the funds can be withdrawn a full calendar year sooner.
RRSP Penalty For Over Contributions
If you contribute more to your RRSP than your allowable deduction limit, you will have to pay a penalty of 1% per month on every dollar over the limit. For Canadians over 19 years of age, there is a $2,000 grace amount for which you won’t be penalized, however, this amount will not be tax deductible.
The only way to remedy this over payment is to withdraw the funds.
If you want to make contributions over the deduction limit for your 2020 tax return, you can wait until the 60-day period in 2021. At this time, 18% of your 2020 income (up to a maximum amount not known at this time) will be added to your total contribution room.
For assistance with your RRSP strategy, please contact us today.
