For most Canadians, their RRSP represents a key source of retirement income, a source that will be accumulated over many years to guarantee the attainment of their retirement objectives. An understanding, accompanied by effective management of your RSP assets will help to ensure the largest possible retirement nestegg.
Basic RRSP Concepts
A Registered Retirement Savings Plan (RRSP) is a tax sheltered investment vehicle that provides individuals with an effective means of saving for retirement. Contributions to an RRSP result in a tax deduction, and the income earned in the plan compounds on a tax-deferred basis. Individuals with RRSP contribution room in Canada may contribute to a RRSP up to the end of the year in which the planholder reaches age 71.
The Benefits of RRSP Investing
While most individuals recognize the benefits of investing in an RRSP, many do not exploit its unique advantages to their fullest potential. There are three primary benefits to investing in an RRSP:
1. Tax savings
Contributions to an RRSP are deductible for tax purposes within certain prescribed limits. In the year a contribution is made to an RSP you can choose to deduct the contribution from your taxable income. This deduction reduces the amount of taxable income and thus the tax payable. The actual tax savings will depend on your marginal tax rate. The table below outlines the amount of tax saved, and the after-tax cost of a $1,000 RRSP contribution based on various marginal tax rates. For Example at a marginal tax rate of 45%, the after tax cost of making a $1000 RRSP contribution is only $550.
2. Tax-deferred compounding
The most significant opportunity offered by the RRSP is the tax-deferred compounding of income earned within the plan. The term "tax-deferred" refers to the fact that all income earned within the RRSP accumulates tax free until withdrawn.
3. Income splitting
Utilizing income splitting strategies between spouses can provide significant tax savings. One of the most simplistic, yet effective methods of income splitting between spouses is achieved by contributing to a spousal RRSP. The objective of this strategy is to provide both spouses with similar retirement incomes and thus similar income tax rates in retirement.