Hopefully, most of you know what an RRSP is. For those who don’t, RRSP stands for Registered Retirement Savings Plan and it’s one of the only tax (and largest) deduction/deferral tools that employed Canadians have. The RRSP account can be opened at any of the big banks along with some online brokerages, and allows your investment growth to compound TAX FREE. On top of that, all contributions for last year, up to March 1 of this year can be deducted from your income. This will equate to a tax return of the sum of your contributions x your marginal tax rate.
For example, if I contributed $6000 to my RRSP for 2006 (up to March 1, 2007) with a marginal tax rate of 38%, I would get a tax return of $2280 ($6000 x 38%). The tax return is free money right? Not so fast, RRSP’s are a tax DEFERRAL tool where you are taxed at your marginal rates when you WITHDRAW. So when it comes time for you to retire, hopefully you’ll be in a lower tax bracket than when you were working.
Now that we’ve gotten some of the formalities out of the way, the question that this article is going to try to answer is, who should contribute to an RRSP?
The simple answer is, anyone who is employed and expects to be in a lower tax bracket when they retire. The real power of RRSP’s though is the ability to let your investments compound TAX FREE. For example, if you were to contribute $200/month to your RRSP at the age of 20, you’d have almost $650,000 in your RRSP at the age of 60 (assuming 8% growth). If you wait until you’re 30 before you contribute, you would have $284,000 at 60. The power of time cannot be understated.
How about a new graduate from University in a low tax bracket?
Even though you are in a low tax bracket, I believe that your RRSP should be “started”. Any deductions can be carried forward to a future year when you reach a higher tax bracket. You young folks out there, take advantage of the power of time and compounding. You can also withdraw from your RRSP in the near future towards the down payment of your first home (HBP).
How about those permanent low income earners?
Low income earners who expect to stay in the same tax bracket for their career should NOT contribute to an RRSP. Reason being is that being in the lowest tax bracket will provide little tax benefits. On top of that, upon retirement, government benefits like GIS (guaranteed income supplement) may be clawed back if you have an RRSP that exceeds the maximum income requirement.
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