Personal Investor: 5 RRSP myths
Midnight Thursday is the deadline to contribute to your registered retirement savings plan if you want to lower your 2017 tax bill. Many people think they know what an RRSP is, but here are five common misunderstandings:
1. You must invest your contribution by the March 1 deadline: Wrong. You only have to contribute by the deadline to be able to apply it to your 2017 taxes. You can park it and invest later or use it for your 2018 taxes.
2. Registered retirement savings plans are a tax exemption: Wrong. RRSPs are tax deferrals and there's a huge difference. An exemption is forever. A deferral means you will have to pay tax at some point in the future. An RRSP is a temporary tax shelter that allows the plan holder to delay paying taxes on contributions until the money is withdrawn. RRSPs are popular because they allow savings to grow tax free until the plan holder is in a lower tax bracket -- normally retirement.
3. You should contribute the maximum allowable amount: Not always. If your RRSP grows too much you will withdraw in a higher tax bracket and the government could claw back your Old Age Security benefits. Claw-backs can be avoided by income splitting where taxable income is split with a lower-income spouse. There's also a strong argument for young investors to delay making RRSP contributions until they are in their higher income years and the tax savings are bigger. The trade-off would be less time to allow savings to grow tax-free.
4. You must take advantage of your maximum allowable contribution the year it is issued: Wrong. The difference between the allowable amount and what you contribute can be used in later years. You can carry forward any amount you don’t use.
5. You cannot make a withdrawal from your RRSP until you retire: Not true. Money from an RRSP is available to the plan holder at any time, but it's important to know there is a withholding tax and it will eventually be taxed at the going rate.
The government allows exemptions such as the Home Buyer's Plan, where first time home buyers can borrow up to $25,000 provided it is paid back within 15 years.
The Lifelong Learning Plan also allows investors to withdraw up to $20,000 tax free for full-time training or post-secondary education. The full amount must be paid back within 10 years.