RRSP is a good tool to save tax. But if you don’t use it well, you may get into RRSP tax traps. Below are RRSP tax tips to help you avoid the tax traps and take good use of your RRSP.

1. Know your marginal tax rate.

It is all about tax rates. If you don’t pay tax, RRSP cannot bring you tax funds. The higher your income is, the higher your marginal tax rate is, and more tax you can save by contributing to RRSP. Check the marginal tax rate table here.

Your RRSP tax saving rate is equal to your marginal tax rate. Therefore, when your income is high, you should contribute to your RRSP; the higher income spouse should contribute to RRSP or spousal RRSP. Use our RRSP tax saving calculator to see how much you can save by contributing to RRSP.

2. Know your retirement income

We already know RRSP withdrawal are taxable income. It affects not only your tax, but also other benefits. Depends on your personal situation, your RRSP withdrawal strategy will be different to others.

For Low-income seniors

If you think your retirement taxable income will be below the maximum amount ($17,088 in 2014) of Guaranteed Income Supplement (GIS), then you should get all your RRSP money out and deposit it into TFSA if possible, preferably before you turn 65 and become eligible to collect GIS. This is because every $100 you withdraw from your RRSP, you will lose $50 from your GIS – equivalent to a 50% tax rate.

For mid-income and high-income seniors

By claiming your basic personal credit, age credit and the pension income credits, you probably should not pay tax for the first $20,000 income. On top of the first $20,000 and below $40,120, the tax rate is %20.05 (2014 tax rate for Ontario residents), and increases as income increases. If your income is more than $71,592, your OAS will be clawed back. Each dollar of income over that amount results in a clawback of 15% from OAS benefits, so it’s equivalent to adding 15% to your overall tax rate.

By knowing the marginal tax rate and projecting your retirement income, you can get a rough sense of the potential tax consequence by withdrawing from your RRSP or RRIF. From that you can assess potential tax spikes and the optimal balanced RRSP withdrawal.

3. Name your RRSP beneficiaries

Holding an RRSP upon death can result in a large tax bill. It’s like taking all your RRSPs out at once and taking the big tax hit in one shot. However, by naming your RRSP benficiaries, you can have your RRSP tax-free rollover to your certain RRSP beneficiaries, including your spouse or common-law partner and financially dependent child or grandchild.

By now, you probably know how to use RRSP to save your tax, and how to use RRSP Home Buyer Plan to fund your first home purchase. You may also know about the advantages of income splitting, although most Canadians have limited opportunities to transfer income from one spouse to another if both are salaried employees.

Spousal RRSP is one of the practical means of income splitting for such couples; they can help defer taxes right away, and reduce taxes in retirement. If one spouse has a significantly higher income now, you should consider taking advantage of a spousal RRSP right away.

What is spousal RRSP?

Spousal RRSP is an RRSP that lower income spouse establishs, but that the higher income spouse or common-law partner contributes to. The lower income spouse is the owner and beneficiary of the spousal RRSP, while the higher income spouse makes the RRSP contribution.

How spousal RRSP help you save taxes

Higher income spouse makes the spousal RRSP contribution, and claims the RRSP tax deduction. Because the higher income spouse is taxed on higher marginal tax rate, by contributing to the spousal RRSP, the higher income spousal can save more tax than the lower income spouse can by contributing to his/her own RRSP.

When it’s time to draw funds from spousal RRSPs, as long as the withdrawal is 3 years after the contributions, the withdrawal amount will be taxed on the lower income spouse. It reduces the family total taxes by paying tax at a lower tax rate. It also help to reduce or eliminate OAS clawbacks on the higher income spouse.

When one spouse or common-law partner has a pension plan and the other does not, it is usually better for the spouse with the pension plan to contribute to the other spouse’s RRSP. When pension benefits are received during the retirement years, the spouse with no pension plan will usually be in a lower tax bracket. The spousal RRSP plan will even the income and reduce familyy overal taxes.

The three year attribution rule

When considering spousal RRSP, you need to understand the three year attribution rule. If your spouse withdraws from the spousal RRSP within three calendar years of your last contribution to your spousal RRSP, the withdrawal is treated as income on your personal tax return. If the withdrawal is made more than three years after the contribution, the withdrawal is treated as income on your spouse’s tax return. For example, if your last contribution was made in December 2011, a withdrawal is taxable as your income until January 2014. Simpely, to avoid the three year attribution rule, your spousal should not withdraw funds less than 3 years of your last spousal RRSP contribution.

If you are planning to buy your first home, RRSP Home Buyer Plan (HBP) may help you come up with extra funds for your mortgage down payment or house renovation.

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The Home Buyers’ Plan (HBP) is a program that allows you to withdraw funds from your RRSPs to buy or build a qualifying home for yourself or for a related person with a disability. You can withdraw up to $25,000 in a calendar year.

RRSP withdrawal conditions under the HBP,

• You have not owned a home which you occupied as your principal residence during the past four years
• You have to be a resident of Canada at the time of the withdrawal.
• You have to receive all withdrawals in the same calendar year.
• You cannot withdraw more than $25,000. If you buy the home with your spouse, common-law partner, or other individuals, each of you can withdraw up to $25,000.
• Your RRSP contributions must remain in the RRSP for at least 90 days before you can withdraw them under the HBP, or the contributions may not be deductible for any year.
• The house you buy must be located in Canada.
• You plan to use the home as a principal residence (not for rental income).

If you make a RRSP Home Buyer Plan withdrawal and a condition is not met, your RRSP withdrawal(s) may not be considered eligible. You will have to include the withdrawal(s) as income on your income tax return for the year you received the funds. You probably have to pay tax on the withdrawal.

You have to repay your HBP withdrawals.

You have up to 15 years to repay to your RRSPs the amounts you withdraw from your RRSPs under the HBP. However, you can repay the full amount into your RRSPs at any time. On your notice of assessment, you can see the required repayment amount. If you do not repay it, you have to include it as RRSP income.

Your repayment period starts the second year following the year you made your withdrawals.

To make a repayment under the HBP, you have to make contributions to your RRSP. While you are preparing your income tax, you can designate all or part of the contribution as a repayment under the HBP.

For instance, if you borrowed $15,000 under the HBP from your RRSP in 2012, the first minimum required repayment is $1,000 (1/15 of $15,000), which will be due in 2014. If you don’t contribute to RRSP to repaid it, you must included this $1,000 as income on line 129 (RRSP income) of your 2014 tax return.

After you know the RRSP tax benefits, you should be aware the RRSP tax disadvantages.

RRSP withdrawals are taxable

Any income you earn in RRSP is tax-free as long as the funds remain in your RRSP. However, you generally have to pay tax when you make withdrawals from RRSP. The only two exceptions are Home Buyers’ Plan and Lifelong Learning Plan withdrawals.

You have to report the withdrawal amount as RRSP income, and put it on the line 129 of your income tax return. It increases your net income, and you pay on the same tax rate as your marginal tax rate. In a simple word, the higher your income is, the more you have to pay for the RRSP withdrawals. For example, if you are making $100,000/year, every $1000 you withdraw from RRSP, you have to pay $434 tax.

RRSP Withholding tax

When you withdraw funds from an RRSP, your financial institution will hold back the tax and pay it directly to the government on your behalf. The withholding tax rates depend on your residency and the amount you withdraw. For residents of Canada, the rates are:

• 10% (5% in Quebec) on amounts up to $5,000;
• 20% (10% in Quebec) on amounts over $5,000 up to including $15,000; and
• 30% (15% in Quebec) on amounts over $15,000.

For funds held in the province of Quebec there will also be provincial tax withheld.

RRSP tax disadvantages at death

When you die, CRA treats the fair market value of your RRSP as income, which is subject to tax at your marginal tax rate. If you have $200,000 in your RRSP, you can expect a tax bill of between $60,000 and $100,000.

You can avoid that tax bill if you pick the right beneficiary. Certain beneficiaries, known as qualified beneficiaries, will be able to receive the funds from your RRSP without anyone paying tax upon your death. Qualified beneficiaries include:

• Spouse or common-law partner
• Financially dependent child or grandchild who is your dependent because of a physical or mental infirmity
• Financially dependent child or grandchild under the age of 18

You cannot claim capital lose inside RRSP.

If there is a loss on the RRSP investment, the Canada Revenue Agency does not allow you to treat it as a capital loss against your RRSP. It is simply a loss and can’t be deducted.

Capital gains are fully taxable when withdrawn from RRSP

Outside your RRSP, capital gains are half-taxable. Inside your RRSP capital gains are eventually fully taxable, once you withdraw it.

Retirees may get less benefit.

RRSP income is taxable. Withdrawals from your RRSP increase your net income. You may lose part or all other government benefits when withdrawing money from RRSP. After you retire, you may be qualified for Guaranteed Income Supplement (GIS) and Old Age Security (OAS). However, if your taxable income is more than $17,088, you are not qualified for the GIS; If your taxable income is more than $71.592, your OAS benefit will be reduced if you take money out of your RRSP.

To avoid these RRSP tax advantages, you need to think about a good strategy for taking the money out in retirement or before retirement. Home Buyers’ Plan (HBP), Lifelong Learning Plan (LLP) and withdrawing money when your income is low are three safe ways to withdraw funds from your RRSP.

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.

RRSP season is coming. When your bank try to sell you an RRSP, do you know what you are really buying, and how the RRSP help you save money? You can find several articles about RRSP from our blog. Let’s start from the RRSP basics.

What is RRSP?.

An RRSP is a retirement savings plan registered with Canada Revenue Agency. An RSSP is not an investment in itself; it is an account that holds investment assets. It was created by the federal government in 1957 to promote savings for retirement by employees and self-employed people.

How do I qualify for contributing to RRSP?

• There is no minimum age for contributing to an RRSP. However, you must be at least 18 to contribute more than $2,000.
• The year you turn 71 is the last year in which you can make a contribution to your RRSP.
• You can contribute to your RRSP and deduct it on your income tax only if you have unused RRSP deduction limit.

How to find out my unused RRSP deduction limit?

There are three ways to find your unused RRSP deduction limit.

• Canada Revenue Agency (CRA) will send you a Notice of Assessment after receiving your income tax return. On your latest notice of assessment, you will see RRSP deduction limit statement. Line A in the statement is the deduction limit you can contribute to your RRSP.
• Call the Canada Revenue Agency TIPS at 1-800-267-6999. You will be asked for your Social Insurance Number, your month and year of birth and the total Income amount you entered on line 150 of your previous year income tax return.
• You can also use the Canada Revenue Agency My Account Service online to find out the limit of your RRSP contributions allowed for your income taxes.

How to claim your RRSP deduction

Deduct your RRSP contributions on line 208 of your income tax return. For 2014, you can deduct contributions you made to your RRSP from January 1, 1991, to March 1, 2015 (the first 60 days of 2014). You can deduct these contributions if you did not deduct them for any other year, and if they are not more than your RRSP deduction limit for 2014.

What are qualified investments on your RRSP

Common types of qualified investments include:

• Cash deposit;
• guaranteed investment certificates (GICs);
• government and corporate bonds;
• mutual funds; and
• securities listed on a designated stock exchange.