TFSA and RRSP Reminder


As we are near the end of January and tax season is around the corner, I would like to remind you about two key tax savings opportunities: TFSA and RRSP.

Tax-Free Savings Account (TFSA)

If you haven’t already made a contribution to your TFSA account this year, make sure you do so at the earliest possible to take advantage of the tax benefits. $6,000 contribution room has been added as of January 1, 2020. Although the contribution is not tax deductible, the income earned within a TFSA is tax-free. 

If you have unused contribution room from previous years, make use of it as well if you have excess disposable income. Your can check your total contribution limit via My Account on the CRA’s webpage.

Let’s go over a common mistake and a strategy you can use for your TFSA.

Over-contribution – the common pitfall 

Many people go over their TFSA contribution limit without knowing it. This happens when they withdraw and re-deposit money in the same year. They’re treating their TFSA like an everyday bank account.

The thing to remember is that on January 1, you gain two things. The first is more contribution room as noted above. The second is the contribution room from withdrawals you made in the previous year.

For example, say you have a total contribution room of $8,000 remaining. You decide to withdraw $20,000 from your TFSA to make a big purchase. Then later in the year, you received an unexpected windfall and put the full $20,000 back in. Since you didn’t wait until the following year to make a contribution, you’ve over-contributed $12,000 for the current year. The CRA charges 1% penalty per month on excess contribution until you take it out. So in this example, you would pay a penalty of $120 per month, and it can take the CRA a few months to let you know.

Top up your unused contribution room

If you have unused TFSA contribution room, one simple strategy is to convert an existing part of your non-registered portfolio to a TFSA. This may trigger a capital gain or a capital loss. 

If a capital gain is triggered, it may result in additional tax liability. However, the gain can be offset by any unused capital loss carried forward from a previous year. Check your latest Notice of Assessment to see if you have any unused capital loss. 

If a capital loss is triggered, make sure you do not violate the superficial loss rules. This happens when you repurchase the same investment within a 30-day period and the capital loss is denied. Capital losses can be carried forward indefinitely to offset against a future year’s capital gain. 

Registered Retirement Savings Plan (RRSP)

TFSA and RRSP are the two most commonly used tax savings vehicles. However, RRSP has a contribution due date, which is coming up on February 29, 2020. Your can check your total contribution limit on your latest Notice of Assessment or via My Account on the CRA’s webpage.

There are 2 key benefits of making an RRSP contribution. First, it is tax deductible in the year of contribution. Second, the income earned within an RRSP is tax-deferred until withdrawal when the tax rate is lower. 

To achieve the greatest tax savings, examine your tax bracket to determine the optimal contribution amount. Every dollar contributed to your RRSP is deductible from your income and you may be eligible for additional tax refund. For example, if you live in Ontario and earned an annual income of $120,000, you are taxed at a marginal rate of 43.41%. If you contribute $10,000 to your RRSP, you would receive a refund of $4,341 or 43.41% of the amount contributed. Your taxable income decreases as your contribution increases, which could move you to a lower tax bracket.

Using RRSP to reduce income at a higher tax bracket is the most commonly used strategy. But there are other ways you can benefit as well from using an RRSP.

Spousal RRSP

If you are married, or in a common-law relationship, consider making an RRSP contribution for your lower income spouse. The main advantage is to lighten the tax load for couples in their retirement. Should one person have a lot of money in their RRSP and the other has less, they would pay more tax at retirement. If each person evened out their contributions, they could potentially pay less tax at retirement by being in a lower tax bracket.

To understand the tax benefits of a spousal RRSP, let’s consider an example. Imagine either you or your spouse/partner earns more than the other. One of you makes $100,000 a year, and the other makes $50,000. Individual RRSP limits are 18% of your income from the previous year’s taxes, up to a maximum dollar amount that changes annually. If both of you have RRSPs to which only the owner could contribute, the person earning $100,000 could put $18,000 into to their RRSP (18% of income) while the person earning $50,000 can contribute the same percentage, $9,000.

When you open a spousal RRSP, you can even things out a little bit. The person earning more money can contribute, say, $14,000 into theirs and $4,000 into their spouse/partner. They can still take the total $18,000 deduction on their income tax (and the other person will still contribute the $9,000 and take that deduction too).

Without a spousal RRSP, one person will have $1 million in savings at retirement while the other will have $400,000. At a standard withdrawal rate of 4%, one spouse will be taking $40,000 income per year and paying a lot more taxes, while the other will only be taking $16,000 per year. If they open a spousal RRSP, they could equalize the retirement savings between them so that each one has around $700,000 and is withdrawing about $28,000 per year.

Spousal RRSPs aren’t just for retirement, though. If one person decides to leave work and stay home with their kids or to go back to school, contributing to a spousal RRSP in advance will allow that person to withdraw money while unemployed and pay a minimal amount of tax (if any). 

One caveat about spousal RRSP. Contributions cannot be withdrawn for three calendar years from the year of contribution. Otherwise, the contributor will be liable for tax upon withdrawal. This is known as the three-year attribution rule. For example, if you recently contributed $5,000 to a spousal RRSP, the money will be added back to your income if it is withdrawn within the next 3 years from the contribution date.

First-time home purchase and school enrollment

If you have been diligently saving to your RRSP and need access to these funds prior to retirement, there are certain programs available. The Home Buyer’s Plan (HBP) can help you purchase a home if you are a new home buyer, and the Lifelong Learning Plan (LLP) can be used to fund tuition fee if you’re going back to school. Each program allows you to borrow funds from your RRSP tax-free subject to later repayment. HBP has a repayment term of 15 years and LLP has a repayment term of 10 years. 

Contribute today but defer the tax deduction

Many people are not aware of this, but you can actually make a contribution without claiming the tax deduction immediately. This strategy is beneficial if you are currently in a low tax bracket but want to take advantage of the tax deferred growth within the RRSP. You can claim the deduction at a later year when you are in a higher tax bracket.

What’s next?

There’s never a better time to start saving than now. Start your 2020 on the right track by taking advantage of the new room created in your TFSA and RRSP. 

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