Figuring out how much to contribute to your RRSP is important. Do it right, and you maximize your tax savings now, while setting yourself up for a good income after retirement. Do it wrong, and you could find yourself paying more taxes than you have to.
Luckily, planning how much to contribute to your RRSP isn’t complicated—once you understand all the moving parts. In this post, we’ll go over everything you need to know to plan your RRSP contributions and maximize the tax advantages.
Who can contribute to an RRSP
You can contribute to an RRSP if you:
- Have earned income
- Have a social insurance number
- Filed a tax return
- Have RRSP contribution room available
- Are under 71. The end of the year that you turn 71 is your last opportunity to contribute.
Before planning your contributions, if you need a refresher on what RRSPs are and how they work, we’ve outlined everything you need to know here.
The 2021 RRSP contribution & deduction limit
There’s a limit to how much you can contribute to your RRSP and it changes each year. For the 2020 tax year, you can contribute up to 18% of the earned income you reported for last year’s taxes (2019 tax filing), or $27,230 —whichever is less.
Fortunately, you’re able to beef up your 2020 contributions even after the calendar turns. The deadline to contribute to your RRSP for the 2020 tax year is March 1, 2021.
Remember, even if you miss the deadline, unused RRSP room carries forward and adds up. If you haven’t maxed out your account in previous years, you should have a considerable amount of space available to you.
How much to contribute to your RRSP
When you contribute to an RRSP, you’re investing towards a better quality of life for your future self. So if you have money to contribute, it’s almost always a good idea to do so.
Generally speaking, you should aim to contribute at least 10% of your gross income each year to your retirement savings.
Start contributing in your early 20s, and that 10% per year could add up to a sizeable savings and a comfortable retirement. Start later in life—say, your late 30s—and 10% a year may not cut it.
To see how much money you can expect in the future from your invested contributions, check out our RRSP calculator.
Find the right number with a financial plan
Keep in mind, these numbers are just general guidelines. Ultimately, the only way to know whether you’re contributing enough is to build a financial plan that accounts for when you plan to retire, all of the different income sources and savings you expect to have, and how much you plan to spend each year. With that information, you can work backwards and figure out whether you’re saving too much or too little.
It can be challenging to DIY a proper financial plan, so we strongly suggest working with a financial adviser for this. CI Direct Investing clients get unlimited access to financial planning at no additional cost. Our advisers can help you build a financial plan and figure out your savings sweet spot.
When you shouldn’t contribute to an RRSP
There are a few instances when you may be better off not contributing to your RRSP, and instead putting your money elsewhere. Here are a few examples:
- If you have high interest debt, such as a credit card balance. Paying down that debt should take priority.
- If your tax bracket is the same or lower than the tax bracket you’re expecting to be in during retirement. In that case, your money may be better off saved in a TFSA until you’re in a higher tax bracket.
- If you’re in a lower tax bracket now, but expect it to increase in the short-term. Say you’re expecting a big raise next year, you might want to use a TFSA for the time being. You can always transfer the money into an RRSP at a later time.
We have a great article that compares RRSPs vs TFSAs, and when you should choose one account over the other.
How to figure out your RRSP contribution limit
To see your current RRSP contribution limit, including value carried forward, look at your most recent notice of assessment from the Canada Revenue Agency (CRA). You get this notice of assessment after filing your tax return.
You can also view your limit using CRA’s My Account. (If you don’t already have a log-in, get one! It will make your life much easier come tax time.)
RRSP contributions & pension adjustments
If you pay into an employer plan such as a pension, that might impact your limit. Your Notice of Assessment from the CRA will show you how your pension adjustment affects your RRSP contribution limit.
Here are some of the ways your employer plan can impact your RRSP limits:
- Pension adjustments and your RRSP contribution limit: If you belong to a pension plan through your employer or union, the amount you are able to contribute to your RRSP is decreased.
- If you have a defined benefit plan, the CRA will estimate the value of the benefit you earned over the course of the prior year.
- If you have a defined contribution or deferred profit sharing plan, the adjustment is the total amount you and your employer contributed during the prior year.
Your Notice of Assessment from the CRA will show you how your pension adjustment affects your RRSP contribution limit.
How to contribute to your RRSP
There are two approaches to planning your RRSP contributions: Short term and long term.
With the short term approach, you contribute as much to your RRSP as possible every year in order to get the biggest tax deduction you can. This may benefit you now, but in retirement it could cost you.
Once you turn 71—or sooner, if you decide—you’ll need to convert your RRSP into a Registered Retirement Income Fund (RRIF). At that point, you’ll be forced to withdraw a minimum amount from your RRIF each year as income. The more money you contribute towards your RRSP today, the more you’ll have to withdraw later.
Keep in mind, if your minimum withdrawal amount ends up being more than you actually need to maintain your lifestyle in retirement, that extra income will put you in a higher tax bracket, so a bigger chunk of your savings will go to taxes.
The long-term approach looks at your needs now, and your needs after retirement. That means figuring out what your living expenses will be after retirement, and saving enough in order to meet them—no more, no less. (For the sake of planning, retirement lasts until you turn 100.)
Any savings in excess of that should go into a TFSA. When you withdraw the money from a TFSA, it won’t be taxed—meaning you’ll remain in a lower tax bracket after retirement.
It’s better not to get overtaxed in the first place. That’s where automatic deposits come in.
Automatic RRSP contributions
The best way to save consistently is to automate deposits to your RRSP on a regular basis, lined up with your payroll. That way, as soon as money comes in, some goes out to savings.
If you start making more money, you should make an adjustment to your savings to keep on track. Review the amount you’re contributing every couple of years, or when you get a major salary increase.
What happens if you over-contribute to your RRSP?
Over-optimizing your RRSP contributions
For most of us, saving too much money for retirement seems like a great problem to have. Still, considering that an RRSP will be taxed on withdrawal, it is possible to save more than you need.
To maximize tax savings over your lifetime, here are a few things to consider:
- Make sure that your marginal tax rate when you contribute is higher than your average tax rate in retirement. You can find your marginal tax rate here, and our TFSA/RRSP calculator can help you determine the best account type for you.
- Only save enough in your RRSP to support your lifestyle until age 100 (at the latest).
- If you’re looking to leave an inheritance for your kids or other loved ones, there may be better ways to do so than through an RRSP, given the taxes. Consider using a TFSA or non-registered account instead.
- If you’ve saved too much in your RRSP and now your RRIF is providing more income than you need, you should save the extra money coming from your RRIF in a TFSA or non-registered account.
Keeping all of this in mind when planning your RRSP contributions will help you get the most out of your money. That way, you’ll pay the least taxes over your lifetime.
Avoid RRSP tax penalties
What happens if you go over your RRSP contribution room?
Good news: The CRA gives you a $2,000 cushion for over contributing to your RRSP. So, you can contribute up to $2,000 over the annual maximum limit without being penalized.
Some people like to intentionally use that $2,000 as “extra space” to contribute more money to their RRSP. We don’t recommend it. Once you use up that $2,000 there’s no room for error. Any overpayment will cost you.
The penalty for overpaying your RRSP is 1% per month for any amount exceeding the $2,000 cushion. If you overpay by accident, exceeding the $2,000 limit, you need to take the extra assets out of your RRSP as soon as possible. Once they’re withdrawn, the CRA will stop charging a 1% monthly penalty on them.
How to claim an RRSP tax deduction
Reporting your RRSP contribution as a deductible expense is fairly straightforward. If you’re filing taxes online and have linked your tax return to your MyCRA account, your 2020 contributions should show up automatically on line 208 of your tax return. Otherwise, your financial institution will send you contribution receipts for any contributions you make before the March 1 deadline. You can add these numbers manually.
Keep in mind you don’t need the actual contribution receipts to file your taxes—you just need to add up the amount you contributed and report the total. Just keep the receipts handy for future reference if you are ever audited.
Deferring RRSP deductions
You don’t actually have to deduct everything you contributed to your RRSP this year.
Any contributions you don’t deduct this year become “unused contributions”. They carry forward into the following year, when you’ll have the option to deduct them again. You’ll need to report these as unused contributions on your tax return.
Contributed assets will still grow in your RRSP account—you just won’t see any savings for them in the tax year you made them.
Why defer RRSP deductions? Doing so can sometimes help you maximize your tax savings.
For instance, if you expect your income to increase in the future, and your tax bracket along with it, waiting to deduct RRSP contributions until that time can help you maximize tax savings.
Similarly, if your tax bracket is lower now than it will be in retirement, you might hold off on making contributions and instead invest through a TFSA.
What to do with your tax return
When you claim your RRSP contributions, you can expect to get a bigger tax refund. This happens because the government collected too much income tax from you, and now they’re paying back the difference. It isn’t a free paycheque.
Want to put your tax return to work for you? Reinvest it.
RRSPs are just one part of your retirement income
When calculating the right amount to contribute, it’s helpful to consider whether you can expect to receive additional income in retirement from sources other than your RRSP (which will be converted to a RRIF). Your retirement income may include money from: the Canada Pension Plan (CPP), any other pension plans you’re a member of, Old Age Security (OAS), and any businesses you may be running post-retirement.
Let’s say you’re getting retirement income from your RRSP, as well as CPP and OAS payments. And you’re also selling vintage 2020s fashion on Etsy. Your income each year will look like this:
RRIF + OAS + CCP + Etsy = Retirement Income
Suppose your Etsy store does really well—today’s young people are crazy about the clothes their grandparents wore back in the 2010s. It could be the case that your income adds up to an even bigger paycheque than you were earning before you retired, pushing you back into a higher tax bracket. Suddenly, your tax savings are nil.
This is why it’s helpful to talk to a financial adviser about your options for retirement, and get their guidance on how to maximize your tax savings. There are a lot of factors to take into account—for instance, minimum annual withdrawal amounts from your RRIF, and OAS clawback. A financial adviser can project into the future for you, and help you plan where to put your savings.
RRSPs can be a smart investment in your future—as long as you know when to contribute to them, and how much. For help setting up a CI Direct Investing RRSP and planning your contributions, book a call with one of our financial advisers.