After you know the RRSP basics, you would like to know how you will benefit by making RRSP contributions. There are four RRSP tax benefits.
1. Tax saving
The well-known RRSP tax benefit is saving your tax. If you have to pay tax, you will pay less tax by contributing to your RRSP. If taxes are already deducted on your paychecks, you will get tax refunds by contributing to RRSP.
Your tax saving rate is equal to your marginal tax rate. Your marginal tax rate increases as your income increases. Simply, the higher your income is, the more RRSP can help you save tax. You can use our RRSP Tax Saving Calculator to estimate how much you can save by contributing to your RRSP.
2. RRSPs grow tax free
This RRSP tax benefit may not bring you much saving at a short term. However, if you look over in a long-term, you can see how powerful it can be.
For example, if your marginal tax rate is 41%, a $50,000 investment in RRSP earning a 6% average annual compound rate of return would grow to $151,280 in 20 years.That same investment in a non tax-sheltered plan would only grow to $96,833. That’s a difference of $54,447.
3. Income splitting opportunity with spousal RRSP
Basically, any amount that you are eligible to contribute to your own RRSP may be directed instead to a spousal RRSP. And the benefits of this strategy are exceptional:
- A spousal RRSP essentially shifts retirement income into the hands of the lower tax-bracket spouse.
- When you contribute to a spousal RRSP, the plan and plan assets are owned and controlled by your spouse. However, you get to personally lower your taxable income by the amount you contribute.
4. It may increase your other benefits
It is not widely known that you may get more governmnt benefits by contributing to RRSP.
An RRSP tax deduction will reduce your net income, which is shown on line 236 of your tax return. This net income amount is used in calculating eligibility for income-tested benefits and credits including:
- Canada Child Tax Benefit
- Québec child assistance payment
- GST/HST credit
- Solidarity tax credit (Quebec)
- Tax credit for child-care expenses (Québec)
- Age credit
- Old-age security pension benefits (OAS)
- Guaranteed Income Supplement (GIS)
- Medical expense tax credit
- Refundable medical expense supplement
For example, you may already know the Canada Child Tax Benfit(CCTB) will be reduced if your family net income is over $43,953. For a one-child family, the reduction is 2% of the amount of your family net income. For families with two or more children, the reduction is 4%. By contributing to your RRSP, your family net income will be reduced. As a result, your CCTB benefit may increase. You can use the CCTB Calculator in CRA website to estimate your CCTB amount.
However, that a withdrawal from your RRSP has the opposite effect – it increases your net income. As a result, you probably have to pay more tax and get less government benefits. As you know, a coin has 2 sides, there are also RRSP Tax Disadvantages you need to know before making your decisions.