The annual RRSP season is winding down. The last day to contribute and use the tax deduction for 2014 is Monday (March 2).
Seriously consider making a contribution if you have not already done so. Years from now you will be happy you did.
An RRSP, which stands for Registered Retirement Savings Plan, is the most popular savings vehicle in Canada. It was introduced in 1957 to encourage Canadians to save for retirement.
The strongest attraction for contributing is the tax benefits and there are many different tax advantages available with an RRSP investment. Your contribution can be claimed as a tax deduction to reduce your taxable income and therefore reduce your income tax.
In addition, savings within an RRSP grow tax-free while they remain in the plan but are fully-taxed when they are withdrawn.
The advantage is taxes can be deferred for years and possibly decades.
There are a few income tax considerations to know about.
What is the marginal tax rate during the year of using a contribution as a tax reduction and what is the anticipated income tax rate at the year that the funds will be withdrawn?
For example, if you save taxes at the rate of 40 per cent for every dollar contributed, then pay income tax during retirement when the RRSP funds are withdrawn at a lower rate of say 25 per cent, then you have reduced your payable taxes.
Most Canadians will likely be in a lower income tax bracket when funds are withdrawn during retirement than they were during their working years. In that case, an RRSP contribution makes perfect sense.
If it is anticipated that you will be in a higher income tax bracket during retirement, then the tax cost of withdrawing funds might offset the tax advantage of claiming those deductions in earlier years when you were at a lower income tax rate.
One consideration to be aware of is that future RRSP withdrawals during retirement will increase your taxable income.
This could lead to the reduction of government benefits including the Old Age Security allowance.
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