Hey welcome back!
Let’s continue with our RRSP journey.
This is a two-part RRSP series.
So, If you haven’t watched my previous one,
I suggest you watch that one first.
Now for part 2, I will talk about 3 things,
What is the deadline for rrsp?
Or is there even one?
Why 18%
What is the rrsp withdraw rules and
when is the best time to do it.
Oh and as usual,
please smash the like button
if you like this kind of content!
Let’s get started
RRSPs is a tax-sheltered account designed
to help Canadian’s plan for their retirement.
RRSPs allow you to defer your taxes
to a future year,
ideally when you retire.
First of all, is there a deadline to
contribute to rrsp offset my taxes.
And the short answer is no.
because you have the whole Jan 1 to dec 31
to contribute to rrsp to offset your taxes
in the same calendar year.
You can do it anytime you want.
However,
there is something called the “first 60 days rule,”
meaning that any RRSP contributions made in
the first 60 days of the year can still count
towards last year’s contribution.
For example. Let’s say we are in 2022 right now.
And Tom is working on his 2021 taxes.
He has the whole 2021 calendar year
to contribute to RRSP.
And on top of that,
he can also contribute more into his rrsp in the
first 60 days of 2022 which is Jan 1 to March 1 2022
That contribution he can either use it to
offset his taxes in 2021 only if he wants to.
Or he can use it towards to his 2022 taxes.
Many many years ago,
the banks know,
most of the Canadians are reactive to things instead
of proactive so the banks see this as an opportunity.
They heavily advertise the first 60 days as rrsp season.
So when the average folks hear about this,
then they will contribute more into the rrsp
or maybe consider for an RRSP loan.
That’s why the key is being proactive.
Don’t wait until Feb to contribute
a huge lump sum into RRSP.
Do monthly automatic contribution.
That way you can reduce the
market risk by dollar cost averaging.
Also, you are not in rush to contribute.
And Speaking of RRSP loan,
I have a video that talks about
the pros and cons for RRSP loan,
be sure to check it out.
One of the most common questions I get asked is
hey Thomas why is the rrsp contribution set
at 18% limit of your income last year,
why not 10% or 20%?
It’s best to illustrate this with an example.
According to statistic Canada,
Canadian will most like be spending 70%
of what they make today for retirement.
So if Peter is making $100,000 now.
Most likely he will need $70,000 when he retires.
And therefore,
he will ideally need $1.4 million in savings.
Why this amount?
Because if you have $1.4 million
and have 5% return per year,
then you have $70,000 per year to
spend without touching the principle.
This gives you a healthy nest egg to live on.
Now the question then becomes how much
and how long and what rate of return
will you need in order to save $1.4 million.
We will work the math backwards.
In order to save $1.4 millions in 35 years,
the average work span and we have a
conservative return rate of average 4% per year,
then we need to contribute $18,000 per year
to have that $1.4 million in 35 years.
Now if you do the math,
18,000 out of 100,000 is … you guess it..
That’s where the 18% limit comes from.
From there, you will understand couple things,
first we need to save consistently
for a long period of time.
2nd you need to have a decent rate of return,
meaning with the current environment,
put everything into a
saving account does not work anymore.
Let time and compound effect do the heavy lifting.
The semi good news is,
it’s easier to get more than 4% nowadays
The S&P 500 index,
for example which most people use as
a benchmark made around 10.5%.
and therefore, we don’t really need to put 18%
or need 35 years to save for retirement.
Now, let's focus on what happens
when you withdraw from your RRSP.
RRSP is a tax deferred tool,
which means when you withdraw the money,
you have pay tax 100% on the withdraw.
Contrary to popular belief,
you don’t actually get penalized for
withdrawing money from your RRSP early.
Yes, You will have to pay tax on it,
however, but you’d have to do that anyway,
no matter when you withdrew the money
– whether you are 30 or 70.
But, of course,
there are a couple major downsides
to withdrawing your RRSPs early.
The first is that obviously,
you don’t let that money grow
tax-shelter within your RRSP.
If you’ve seen my other videos,
I’ve shown you the advantages of
compound interest over time –
especially when you don’t have
to pay tax on your capital gains.
Another downside when you withdraw money
from your RRSP is that
you do not regain this contribution room.
That room is gone forever.
This is very different from the TFSA say where if I
was to withdraw $80,000 for your TFSA this year,
you would regain that contribution room next year.
But this doesn't work for RRSPs.
As soon as you make a withdrawal from your RRSP,
that contribution room is gone forever.
You can never put that money back in.
However,
There are two exceptions that you don’t
have to pay the tax when you withdraw,
the Home Buyer's plan and the Lifelong Learning Plan.
The home buyer’s plan is to help you buy a house
and the Lifelong Learning Plan is if
either you or your spouse wish to go back to school.
These two programs can help you fund the purchase
of your first home or fund post-secondary education
for you or your spouse, but not for your kids.
These are very popular programs,
but there are some rules to consider,
and they're not always the best route to take.
And Lastly,
you’re probably earning more income if you
withdraw early so you’d be taxed at a higher rate.
If you have a high salary,
you'll be in a high tax bracket.
Now if you made the same withdrawal
out of your RRSP during retirement,
your income will be much smaller
and so you'll pay much less tax.
Let's go over an example.
Let's say you have an income of $100,000 per year.
Roughly you will be paying 25% of taxes,
meaning 25,000 goes to the CRA.
So in theory,
every dollar you put into rrsp,
you will save 25 cents in taxes..
However,
if you take out 20,000 from the rrsp for emergency,
then it will add towards your total income which is
now 120,000 which means the tax backet is at 28%.
You have to pay 33,000 in taxes.
Now, let's see what happens if you make
the same withdrawal during retirement
when you have a lower income.
Let's say you have a pension
that pays out $30,000 per year.
And now you take out the
same $20,000 out of the RRSP.
Which makes your income $50,000.
The average tax bracket is at 20%.
Which is 10,000,
A big difference from the $33,000 you
would pay if you took it out early.
And not only that,
in order to prevent you from not able to
pay the tax from the rrsp withdraw.
your bank or financial institution will
immediately charge you a withholding tax.
Let's break down how withholding taxes work.
If you withdraw $5,000 or less from your RRSP,
you'll pay 10% in withholding taxes
and you'll keep 4500 or less.
If you withdraw between 5,000 and $15,000,
you'll pay 20% upfront.
And if you withdraw more than $15,000,
you'll pay 30% right away in withholding taxes.
Meaning if you need $20,000,
you need to withdraw 30000 from your rrsp,
let them withhold 30%.
You get 20,000 but you are taxes at 30,000.
Then at the end of the year,
when you file your taxes,
you'll either receive a tax refund if
you pay too much in withholding taxes
or you'll have to pay even more in taxes,
if there's a difference.
Remember, Withholding tax isn’t a penalty,
but it does force you to pay
some taxes upfront and then pay
the rest when you file your tax returns.
A little neat trick is.
If you really need 20,000 dollar from your rrsp.
Don’t take it out in a lump sum,
instead do 4 times of 5000 withdraw.
That way you save a bit in the withholding tax.
But remember you might need to write
a cheque back to cra when you file your taxes.
Even in retirement,
when you withdraw that money from your RRSP,
be prepared to pay the withholding tax upfront.
If you want to avoid that during your retirement,
before the age of 71,
you have to option to convert your RRSP into
a RRIF, a Registered Retirement income fund.
You are required to withdraw
a certain amount per year,
but that amount is free of withholding tax.
However, you are also mandatory to
switch from RRSP to RRIF after the age of 71.
So soon or later you still need
to start withdrawing but you
can take advantage of the timing.
The amount you require to
withdraw is determined by your age.
If you’re 75,
you take 5.82% out of your entire RRIF account.
and by the time you are age 90,
the rate shoots up to 12%.
You will still have to pay taxes on
these withdrawals just like an RRSP.
So that’s why it’s not a good idea to have
too much in RRSP in your retirement years.
You might have to pay more taxes and
not mentioning losing some of the
government benefits like OAS.
I will share more about RRIF in the future videos.
For now, I will say,
RRSP is a great tool for us to offset taxes,
using the current pre tax money to
fund our retirement or pay for our house.
The higher your income, the better it is.
However, it definitely requires your attention
say 10 years before you retire.
The Banks will always promote
how good it is when you deposit,
but they fail to tell you the other side of the story.
So If you found this all confusing,
then you’re not alone.
It can be very complicated so once again
please talk to your financial advisor about
your specific situation before moving forward.
Alright,
please let me know in the comment section
if you like this video or not!
Thanks so much for watching guys!
See you in the next video!