This year, the registered retirement saving plan (RRSP) turns 55, an age which many Canadians have targeted for retirement. You would think that the basic idea behind RRSPs—the straightforward notion of contributing savings to a registered plan in which earned income would remain tax-free so long as it remained in the plan—would be ingrained in Canadians’ minds.
Yet based on the fact that for the past two years, only about a quarter of eligible tax filers actually contributed to RRSPs, it would be unwise to assume that most investors are truly familiar with even the basics of these plans, let alone the strategies they can use to improve their tax picture.
Since we’re now well into the 2012 RRSP season, it’s a good time to quickly review the fundamentals and discuss some of the strategies your clients can use to enhance their savings.
The essentials
Investors, their spouses or common-law partners are allowed to contribute cash or “in kind” contributions, such as equity and fixed-income investments at fair market value to RRSPs. These contributions generate deductions that are reported on line 208 of their income tax returns. The allowable sizes of these deductions in any given year are determined by the amount that has been contributed previously to their plans, and by their RRSP deduction limits.
The RRSP deduction limit refers to the maximum amount they can deduct from contributions made either to their own plans or to their spouses’ or common-law partners’ plans in the previous taxation year. Limits are calculated using a variety of factors, including the previous year’s earned income, past service pension adjustments, pension adjustments reversals and unused RRSP deduction room from previous years. Deduction limits are also partly determined by the federally mandated RRSP dollar limit. That refers to the maximum amount of new RRSP deduction room that can be created in a particular year. For 2011, the limit was $22,450, but it will rise to $22,970 in 2012 and to $23,820 in 2013.
Broadly, the deductions your clients make on their tax returns for their RRSPs cannot exceed the dollar limit, their deduction limits, or a combination of unused contributions from a previous year, contributions for the current year and contributions made within 60 days of the December 31 tax year-end.
Clients should also be familiar with other fundamental aspects of RRSPs, including excess contributions and, as mentioned above, unused contributions. While there is an allowable lifetime $2,000 over-contribution, excess contributions are penalized at a rate of 1% per month.
The latter refers to contributions made to an RRSP, but that an individual either could not deduct or chose not to deduct. Either that, or they were contributions not designated as a Home Buyers’ Plan (HBP) or Lifelong Learning Plan repayment in a given year. These amounts can be carried forward to the next year so long as they do not exceed the individual’s deduction limit. The notion of unused contributions is distinct from unused deduction room, which simply refers to the difference between an individual’s RRSP deduction limit for a year less the amount actually deducted.
