February means many things for Canadians. For some, it’s the start of slowly warming weather following the biting cold of January. Others see it as the perfect time to go on a sun filled trip to the Caribbean. For most of us, February also means RRSP reason.
This is the time of the year when many Canadians hurriedly make contributions to RRSP accounts to maximize their tax refunds in the spring. If you feel like you haven’t contributed enough in 2018, there is no better time than now to contribute.
How much is enough?
This of courses raises the question, how much should I contribute? As with many things in finance, the answer depends on several factors. Do you currently have automatic payroll deductions set up? And if so, how much as a percentage of your salary have you been contributing in 2018? Many financial planners advise individuals to set aside no less than 10% of their salary for retirement savings. So let’s say for example we had an employee (we’ll call her Ashley) who earns $55,000 a year and has been contributing $400 every month in 2018 for a total of $4,800. Since 10% of Ashley’s salary is $5,500, this means she has a shortfall of at least $700 which she can make up with an RRSP contribution before the March 1 deadline.
The math however, is not always that simple. The 10% minimum guideline assumes someone has been contributing consistently since their 20s and would continue to do so until they retire in their 60s. If you haven’t been contributing that much in the past or have had extended periods of time when you were unemployed, you may need to raise your contributions well beyond 10%. If your employer offers you matching contributions, that should lighten the burden to a degree. The Open Access Retirement Calculator can provide contribution recommendations more customized to your situation
Always remember that guidelines such as the minimum 10% contributions are just that, guidelines. People have widely varying outlooks for retirement and depending on your personal situation, the 10% ‘rule’ may not apply. Life expectancy and desired lifestyle in retirement are factors you should certainly consider when determining how much you ought to contribute.
To be on the safe side, it’s always advisable to raise your contributions beyond the recommended minimum. Your future self is quite unlikely to begrudge present-day you for over contributing during your working life. On the contrary, having a financial cushion in retirement can reduce stress and leave you with more opportunities to enjoy your golden years.
At the same time, remember that there is a limit on the amount you are able to contribute each year. This is 18% of your earned income from the previous year up to a certain cap ($26,230 for 2018). Note that if you are participating in a workplace pension plan, this will reduce your contribution limit. Fortunately, if you have not been maxing your RRSP contributions in the past, your unused contribution room can be added to your limit.
Contributing to your RRSP before the deadline can have a material impact on your tax return. By reducing your net income on the tax return, RRSP contributions effectively put you in a lower tax bracket. For instance, if you earned $60,000 in 2018 and assuming your payroll department correctly deducted your income taxes (putting you in a break-even situation), a $6,000 RRSP contribution would provide you with a tax refund of $1,779.
While the short-term benefit of contributing to your RRSP can be quite material, the long-term gain is even more so. When you set aside money in your RRSP, it will grow in a tax-sheltered environment until you withdraw it. To put this in perspective, a one-time contribution of $10,000 placed in an investment yielding average annual returns of 6% will grow to be $32,071 in twenty years. This is without factoring additional contributions during that time period. Such is the power of compound growth!
For those of us without access to a Defined Benefit pension plan, an RRSP is a great saving vehicle with many incentives designed to help us maximize the size of our nest eggs. Setting up automatic payroll deductions is perhaps the most effective RRSP strategy as it gives your contributions more consistency and discipline. However if you fell short of your desired contributions in 2018, now is the time to make up the shortfall.
Open Access is a discretionary manager of group retirement plans. Being a fiduciary, we are legally and structurally bound to act in the best interests, and only the best interests, of our clients. This means no proprietary products, no conflicts of interest, and no hidden fees.