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RRSP Tax Planning - How it actually works

Retirement planning can be a tricky and often overwhelming process. One of the most important things to consider is investing in Registered Retirement Savings Plans (RRSPs). RRSPs are tax-sheltered savings plans that give you additional tax benefits over traditional savings plans. They also provide a secure way to save for retirement while reducing your taxable income.

 

IMPORTANT DIFFERENTIATION!

You don't 'buy RRSPs'. Think of the RRSP as the TAX BOX, and the stuff that you can put INSIDE the RRSP are the investments.

 

When using an RRSP to save for retirement, it's important to consider how much you can contribute, how long you can invest, and the types of investments that are available to you.

The amount you can contribute to an RRSP depends on your income and whether you have contributed to an RRSP in the past. Generally, the maximum amount you can contribute each year is 18% of your prior year's earned income up to a maximum of $31,560 for the 2023 tax year. You can also carry forward unused contributions, so if you haven't made any contributions in that time, you can still take advantage of the tax benefits.


What are those tax benefits? An RRSP contribution gives you a TAX DEDUCTION against your earned income. That is, if you earn $75,000 and make a $5,000 RRSP contribution, your taxable income is reduced to $70,000. That means you only pay tax on $70,000 instead of $75,000.

In this circumstance, the higher your income, the more of an advantage this can be to you, as you will likely be at a much higher marginal tax bracket. The more income you make, the more significan that tax deduction can become. For example, the highest wage earners in Ontario would receive a tax deduction of 53.53% on any RRSP contributions made on income over $235,675 in 2023.

Working Example? Lets say you've been at a low paying job for a while, and have not been able to afford making RRSP contributions. Despite not having done so, you are still accumulating RRSP contribution room even if you haven't been making any savings into your RRSP. This amount can be found on your last Notice of Assessment from your most recently filed tax return.


Now, in that same example, you've recently landed a new (and much higher paying) job. You are now able to afford making RRSP contributions. Now you can take advantage of all of the accumulated RRSP contribution room that you haven't been able to access in your lower earnings years, and receive a tax deduction at a higher tax rate, as you now earn more income. Check out the table below to see where YOUR marginal tax rate is, and how much of a tax deduction you could receive for making an RRSP contribution to lower your taxable income.

TABLE OF MARGINAL TAX RATES FOR ONTARIO RESIDENTS - 2022 and 2023

Source: taxtips.ca


Any investment earnings inside the RRSP box are tax-sheltered. This means that they do not attract tax as long as they remain in the box. You are only taxed when you withdraw funds from your RRSP, at which point the withdrawal is fully taxable as income.


When it comes to retirement planning, RRSPs are a great way to save for your future and reduce your taxable income. With careful planning, you can make the most of your RRSP and maximize your tax savings.

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