RRSPs Explained

What is an RRSP?

It is a government-approved (i.e. Registered) tax deferral plan through which individuals save money for retirement. Contributions are invested and may earn interest, dividends or capital gains, depending on the plan chosen by the taxpayer.

The benefits of an RRSP plan are twofold. First, contributions are eligible for a tax deduction currently and second, the earnings accumulate in the plan free of tax. When money is withdrawn from the plan, ideally upon retirement, it will then be subject to income tax, anticipated to be at a lower rate.

Who Can Contribute to an RRSP?

Any individual with “earned income” can make contributions in any year until December 31st of the year of the plan holder’s 69th birthday. Note that it’s the plan holder’s age, not the contributor. Normally, you have 60 days after December 31 to contribute for the prior year (up to March 1 of the following year).

What is Earned Income?

Earned income for the year is income from the following:

• Salary, wages, bonuses and taxable benefits (eg. company car), minus union or professional dues and employment expenses.
• Net income from self-employment or a business in which you were an active partner.
• Taxable alimony or separation allowances.
• Royalties, research grants, and supplementary employment insurance benefits (but not regular EI).
• Rental income from real property.
• Disability benefits from CPP/QPP.

Minus the total of the following:

• Current year net loss from business or partnership.
• Current year rental loss on real property.
• Deductible alimony or separation allowance

Items not included in earned income:
RRSP, RRIF, OAS and CPP pension income; death benefits; interest; dividends; EI benefits; scholarships and bursaries; limited partnership income; taxable capital gains and WCB.

RRSP Deduction Limits

The current limitation for RRSP contributions is the lesser of 18% of the individual’s prior year earned income (with a maximum limit set each year). Revenue Canada advises taxpayers of their contribution limit on their tax Notice of Assessment. You should check their calculations as there may be changes due to reassessments, adjustments or errors.

In order to qualify for a full contribution for the taxation year, the individual must have earned income (see page 1 for details) of 100,000 in the prior year. If you are a member of a registered pension plan through your employment, your deduction limit will be reduced by the value of pension benefits accruing to you as an employee. This reduction is called the Pension Adjustment (or P.A.). The prior year’s P.A. will be used when calculating the current year’s contribution limit. Your employer will report the amount of your P.A. for each year on your T4 slip.

You can carry forward your unused RRSP room. For example, if your earned income in 2007 was $50,000, your maximum contribution for 2008 was $9,000 (at 18%). If you only contributed $5,000, then your 2008 room will increase by $4,000. In addition to the carry forward of RRSP room, you can make a one-time excess contribution of up to $2,000. However, be sure not to forget about this excess, as you will want to use the deduction at some point in the future.