RRSP as a tax saving tool
(Disclaimer: Following article is only for information purposes and does not constitute any kind of tax advice. Although best efforts are made to ensure that all information is accurate and up to date, occasionally unintended errors and misprints may occur.)
A study by BMO in 2021 found that 71% of Canadians are aware of RRSP contributions, while StatsCan put a number of Canadians who contribute to RRSPs at around 6 million, which is less than half of full-time workers in Canada and even less when self-employed are included. Millions of Canadians are aware of RRSP but choose not to contribute. While there is much genuine reason as to why people choose not to contribute or defer the contributions, there is also a myth that RRSP does not result in actual tax savings as taxes need to be paid at the time of withdrawal. While it is true that taxes need to be paid at the time of withdrawal of RRSP, it can still be used as a tax-saving tool by using tax slab arbitrage.
Registered Retirement Savings Plan (RRSP), as the name suggests, is a tool meant to put away savings to be used after a taxpayer’s retirement. Canadian tax laws incentivize this by deducting the contribution made to RRSP from the income of the taxpayer, thereby saving the tax payable. However, tax is payable whenever the amount is withdrawn. Since amounts are meant to be withdrawn after retirement when the taxpayer is having a lower income, the tax payable on withdrawal is at a lower rate compared to tax saved when the taxpayer is in a higher tax slab. For example, a person earning $100,000 in Ontario in 2021 will save approximately 43% of RRSP contribution, while a retiree who has other incomes of $30,000 will pay 20% tax on the amount of RRSP withdrawal.
The above-explained tax slab arbitrage can be used not just in arbitrage, but also in other years especially if there is considerable fluctuation in income, like for self-employed taxpayers. RRSP contribution may be made in years when the income of a taxpayer is higher and withdrawn when income is considerably lower. This will help not just in taxes but providing liquidity during a year of low income.
Other things to remember about RRSP:
It's always better to double-check your contribution room before contributing as there is a penalty of 1% per month on overcontribution above $2000. You can find your contribution room on the last Notice of Assessment or in CRA My Account.
RRSP contribution room is generated/available only on earned income (salary, self-employment etc.). So, dividend, interest income etc. doesn’t count towards it.
While individual circumstances may differ, it is generally not advisable to contribute to RRSP when your income is low, as tax savings will be lower. Any unused contribution room can be carried forward.
If your employer is offering to match/contribute to your RRSP, just take it. It is the icing on the cake and sometimes a second cake.
