RRSP: It’s about more than just tax deferral
March 1 is the deadline to make your 2016 Registered Retirement Savings Plans (RRSP) contribution, and while many people wait until the last minute, the most important thing is to get it done.
People understand there are tax-deferral advantages to RRSPs but they may not be aware of all of its benefits.
Tax-deferred savings are a clear benefit. Funds in an RRSP — including deposits, interest or dividends — are sheltered from tax until they are withdrawn. If you wait until retirement when your income is significantly less or even zero, proceeds from the account will be taxed at a significantly lower income rate.
The power of tax-deferred savings is best illustrated by the “Rule of 72.” Dividing 72 by the annual rate of return will provide an estimate of how many years it will take for the initial investment to double.
For example, if we consider an 18-year-old who invests just $5,000 in a tax-deferred RRSP, it earns an average interest rate of eight per cent over a period of years. The original investment would double every nine years, and over time, significant growth is realized.
Age Value of Investment
18 years $5,000
27 years $10,000
36 years $20,000
45 years $40,000
54 years $80,000
63 years $160,000
72 years $320,000
While this example assumes an annual rate of return of eight per cent when you consider the compounding growth of larger or multiple investments, these numbers could really add up. Sheltering this money in an RRSP can save significant tax dollars.
Spousal RRSPs are another benefit that lawyers who are the primary wage earner should consider. If you earn more than your spouse, you still get the immediate tax benefit, but you are also building a nest egg that when taken out on retirement may have fewer tax consequences. Many people don't realize the spousal RRSP still provides a tax deduction for the person making the contribution.
As you transition into retirement, if you’re still generating income but your significant other isn’t, you can take the money out of your spouse’s RRSP and it will be taxed at a much lower rate.
Another key benefit that is underutilized involves leveraging RRSP savings before retirement. RRSPs can be used to borrow money for either a first home with the Home Buyers Plan (HBP) to a maximum of $25,000, or for education under the Lifelong Learning Plan (LLP) to a maximum of $20,000. Borrowers in the HBP have 15 years to repay the loan, while students have 10 years to repay the LLP.
Lawyers excel at mapping out their cases and arguments, but they may be overlooking their long-term financial well-being, and every financial strategy is geared towards retirement in one way or another.
According to an Ipsos poll, while 43 per cent of Canadians say they have a financial plan, 33 per cent indicate that it is located "in their head."
Lawyers follow the general population in this sense. They’re very smart people but they often don’t take the time to fully prepare for their financial future.
A documented financial strategy is something that everyone should have. How are you going to sustain your lifestyle — and pay for your health-care needs considering you’re going to live 10, 20 or more years — after you no longer have a regular income?
The March 1 deadline is quickly approaching and people can determine their contribution limits on the RRSP notice of assessment based on their previous year's tax return.
One caution: Make sure you don’t over-contribute to your RRSP because there are significant penalties for that.
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