Putting money away in an RRSP is the popular Canadian way to save for retirement. And, when you think about it, why not?
The government offers a tax-sheltered account to grow your funds during your working years, and will only tax the money when you start making withdrawals.
Because your RRSP account is not being taxed while you are solely making contributions to it, you are allowed to claim a tax deduction on contributions made.
As with everything “government,” there are a few rules governing the RRSP account which you should understand if you want to make the best use of it.
RRSP Deduction Limit
Every year, you can contribute 18% of your “earned” income for the previous year up to a maximum amount set by the government. In 2021, the maximum contribution amount was $27,830. For 2022, it is $29,210.
Your total RRSP deduction limit may differ from your annual contribution amount for the year and this may be due to you having unused RRSP deduction room carried forward from previous years.
Other factors that influence your overall RRSP deduction limit include:
- Pension adjustment through a registered pension plan (RPP) or deferred profit-sharing pension plan (DPSP).
- Contributions to a spousal RRSP
- Past service pension adjustments (PSPA)
- Pension adjustment reversals (PAR)
You can manually calculate your RRSP deduction limit using the formula:
Unused RRSP contribution room from previous years plus (+) contribution amount for the current year minus (–) any pension adjustment from previous year minus (-) PSPA (if applicable) plus (+) PAR (if applicable)
The easiest way to confirm your deduction limit is to look at the Notice of Assessment sent to you by the Canada Revenue Agency after you filed your taxes. You can also access your numbers via your CRA My Account.
RRSP Contribution Room Carry Forward Rule
You can carry forward the RRSP contribution room that you are unable to use in any particular year. This unused contribution room can be carried forward indefinitely…well, until you turn 71 years of age and can no longer have an RRSP account.
The ability to carry forward unused RRSP room means that an inability to contribute due to a lack of funds in any one year will not result in a loss of contribution room, but it will accumulate instead.
For Example: If in 2019, 2020, and 2021, you were eligible to contribute $5,000, $7,500, and $10,000 respectively to your RRSP, however, you were not able to contribute. This means that in 2022, you have a total contribution room carry forward of:
- ($5,000 + $7,500 + $10,000) = $22,500
RRSP Tax Deduction Carry Forward Rule
Any contribution you make to your RRSP reduces your taxable income. At tax time, you can claim a tax deduction for your contribution amount which then results in a tax refund based on your marginal tax rate.
There may be instances where it makes sense to carry forward this tax deduction claim to a future year when you are in a higher tax bracket, so you can get back more in tax refunds.
For Example: If you contribute $10,000, your tax refund when based on a marginal tax rate of:
- 20% = $10,000 x 20% = $2,000
- 30% = $10,000 x 30% = $3,000
- 40% = $10,000 x 40% = $4,000
The higher your marginal tax rate, the higher the tax you save on RRSP contributions. An RRSP tax deduction can also be carried forward indefinitely.
RRSP Over-Contribution Limit
Like the TFSA, there are penalties for over-contributing to your RRSP. The government allows you a $2,000-lifetime buffer in over-contributions without a penalty. When you exceed this amount, you are required to pay a 1% penalty tax per month on any excess amounts.
For Example: If your RRSP deduction limit is $10,000 and you contribute $15,000, your RRSP over-contribution amount is as follows:
$15,000 – ($10,000 + $2,000 allowed excess) = $3,000
Each month you will be charged a 1% penalty tax on the $3,000 excess amount, equivalent to $30 per month or $360 per year.
If you find out you have over-contributed to your RRSP, withdraw the excess amount as soon as possible. You will have to complete Form T1-OVP. In some cases, you may be able to request a penalty waiver from CRA and would be required to complete Form T3012A.
Excess RRSP contributions cannot be used to claim a tax deduction.
You may also like:
- Everything You Need To Know About RRSPs
- How to Generate Regular Income From an RRSP
- Understanding the OAS
- What Happens To Your RRSP, RRIF, and TFSA After Death
- LIRA, LRSP, LIF, LRIF, PRIF: What Do They Mean?
- 10 Financial Steps To Take Before You Retire
Also, here are some RRSP investments to consider in 2022!