How Much RRSP Should I Contribute To Avoid Paying Taxes?

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by Enoch Omololu

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When someone inquires about how much RRSP they should contribute to avoid paying taxes, three things come to mind.

They could be thinking about limiting the taxes they pay when they start making withdrawals from your RRSP in retirement.

Alternatively, they may be concerned about the over-contribution penalty CRA levies when you put too much money in your RRSP account.

Lastly, they could also be considering how much RRSP is too big. Are they saving too much and will the government end up with a chunk of their RRSP when they pass?

Let us dig further into all three possibilities and how your RRSP contributions and taxes interact.

RRSP Taxes When You Receive Payments

RRSPs offer several benefits including tax-free investment growth, tax-deductible contributions, and more.

When making contributions and investing in your RRSP, you don’t pay taxes on investment income earned, be it interest, dividends, or capital gains.

That said, when you make a withdrawal from your RRSP, the amount is subject to taxation at your marginal tax rate.

Assuming you will be in a lower tax bracket in retirement, you could be better off investing in an RRSP as opposed to a TFSA.

For example, let’s assume you earn $95,000 and have a marginal tax rate of 43.40% (Manitoba). You contribute $10,000 to your RRSP each year for 30 years and when you retire, your annual income is $60,000 with a marginal rate of 33.25%.

Your initial $10,000 contribution will grow as follows:

 TFSARRSP
Income contributed$10,000$10,000
Taxes at 43.40%$4,340$0
After-tax contribution$5,660$10,000
Investment return/year7%7%
Number of years3030
Value of initial $10,000 investment in 30 years$43,086$76,123
Taxes at 33.25% in retirement$0$25,311
Net income after tax$43,086$50,812

Because your marginal tax rate is significantly lower during retirement, the RRSP works better, and you keep more money in your wallet.

If we reverse our tax rate assumptions and your marginal tax rate is higher in retirement, below is what your first $10,000 pre-tax income contribution looks like.

 TFSARRSP
Income contribution (pre-tax)$10,000$10,000
Taxes at 33.25%$3,325$0
After-tax contribution$6,675$10,000
Investment return/year7%7%
Number of years3030
Value of initial $10,000 investment in 30 years$50,812$76,123
Taxes at 43.40% in retirement$0$33,037
Value income after tax$50,812$43,086

In this case, a TFSA could have served you better as you are now paying higher taxes on your RRSP.

Your tax rate in retirement is just one of many factors to consider when choosing between an RRSP and a TFSA.

Other factors include the benefits that accrue from investing your tax refund (from claiming an RRSP deduction on your tax return), employer contribution matching which can significantly boost your RRSP account, and the impact of RRSP income on other income-tested benefits.

So, are there ways to avoid paying taxes on your RRSP withdrawals?

Apart from taking money out for buying a home or for school expenses, you could avoid paying federal taxes on your RRSP if your withdrawal limits your total income to the basic personal amount (BPA) maximum. The BPA in 2022 is $14,398.

How Much RRSP Should I Contribute To Avoid Paying Taxes in canada

RRSP Over Contribution Tax

Overcontributing to your RRSP will cost you and this is a tax you can easily avoid by keeping tabs on your contribution room.

A 1% monthly penalty is assessed on RRSP contributions that exceed your deduction limit by more than $2,000.

For example, if your RRSP deduction limit is $15,000 and you contribute $20,000, your RRSP over contribution amount is:

$20,000 – ($15,000 + $2,000 buffer) = $3,000 excess contribution.

You will pay a 1% penalty tax each month on this excess contribution. Using the example above, this penalty is equivalent to $30/month or $360/year.

You can avoid paying the over-contribution tax by withdrawing the excess amount from your RRSP before the end of the month when the contribution was made.

In a case where taxes are due, you must complete Form T1-OVP and send it to the CRA as soon as possible.

An additional late-filing penalty may be charged if you haven’t filed this form 90 days after the end of the tax year. The late-filing penalty is equivalent to 5% of the balance owing plus 1% of the balance owing every month (up to a maximum of 12 months).

RRSP Taxes After Death

Unless you have designated a qualified beneficiary for your RRSP, its assets are included in your final income tax return and taxed at your marginal tax rate.

However, if you have designated a spouse, your RRSP assets can be transferred to their RRSP account (this also applies to RRIFs) and taxes will remain deferred until withdrawals are made.

You could also defer taxes on your RRSP after passing by designating a financially dependent under age 18, or financially dependent child at any age if they have a qualifying physical or mental impairment.

Learn more about RRSPs after death.

If you don’t have a beneficiary for your RRSP or would rather leave little to nothing for the tax man, you can factor this into the size of your RRSP, your withdrawals in retirement, and how you use your TFSA.

How Much RRSP Should I Contribute To Avoid Paying Taxes?

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Author

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Enoch Omololu

Enoch Omololu is a personal finance expert and a veterinarian. He has a master’s degree in Finance and Investment Management from the University of Aberdeen Business School (Scotland) and has completed several courses and certificates in finance, including the Canadian Securities Course. He also has an MSc. in Agricultural Economics from the University of Manitoba and a Doctor of Veterinary Medicine degree from the University of Ibadan. Enoch has a passion for helping others win with their personal finances and has been writing about money matters for over a decade. He has been featured or quoted in The Globe and Mail, Winnipeg Free Press, Wealthsimple, Financial Post, Toronto Star, CTV News, Canadian Securities Exchange, Credit Canada, National Post, CIBC, and many other personal finance publications.

His top investment tools include Wealthsimple and Questrade. He earns cash back on purchases using KOHO, monitors his credit score for free using Borrowell, and earns interest on savings through EQ Bank.

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