5 Reasons to Consider Making an RRSP Contribution in 2020-2021
Making a contribution to a Registered Retirement Savings Plan (RRSP) in 2020-2021 may be more important than ever. Here are 5 reasons to consider.
1. Save for retirement by contributing by the RRSP deadline
Whether your RRSP contribution will be large or small this year, it may be more important than ever to ascertain what retirement savings you will need and how you will fund a comfortable retirement.
Many Canadians may not have saved enough money to fund their retirement. This year, a part of staying safe may include staying financially safe. Evaluating your plan to save for retirement and determining how much you can contribute to your retirement savings can help you in the future. You can make an RRSP contribution for the 2020 taxation year by the RRSP contribution deadline, March 1st, 2021.
A Government of Canada study "Canadians and their Money: Key Findings from the 2019 Canadian Financial Capability Survey" 1 indicates that 69% of Canadians are preparing financially for retirement.
The study indicates that anxiety regarding retirement savings is focused among Canadians who may be likely to depend on public benefits such as the Canada Pension Plan, Québec Pension Plan or Old Age Security.
The study states that 47% of Canadians say they know how much they will need to save.
- As stated in the study, the individuals who have their own retirement savings plans are confident that their savings will provide the standard of living they hope for in retirement.
- The study indicates that Canadians who have not yet made a plan to save for their retirement may be anxious about possibly not having adequate savings to live on later in life. Having a plan to make RRSP contributions could help to build confidence about the future.
How much retirement savings will you need?
Without knowing how long retirement will last, planning how much to save may seem like guesswork. However, being realistic about the spending habits you expect to have can be helpful in defining your retirement portfolio's size.
There are different schools of thought regarding how much money you may need for retirement – as well as how to arrive at the percentage or dollar amount that you may require.
Savvynewcanadians.com indicates that to determine an actual required figure, you can multiply the yearly retirement expenses you expect to need x 25.
However, while newswire.ca reports that retirees could expect to spend approximately 70%-80% of their pre-retirement budget, Human Resources Director magazine (hcamag.com) suggests that Canadian employees may need 11 times their final pay to retain their pre-retirement standard of living when they retire.
The long and the short of determining how much retirement savings you will need will depend on each individual’s circumstances and requires planning.
2. Potentially pay less tax on your income tax return
Making an RRSP contribution can potentially reduce the amount of tax you will be subject to pay on your income tax return.
- The way an RRSP works is that it helps you save for the future while deferring tax. The amount you contribute to your RRSP is deducted from your taxable income in the year of the contribution. By the end of the year in which you turn 71, your RRSP must either be transferred to a Registered Retirement Income Fund (RRIF) or a Life Annuity, or be withdrawn in cash. A RRIF is designed to provide you with retirement income.
- In retirement, your other sources of income may potentially be lower than they were in the years you were funding your RRSP, and amounts withdrawn from the RRIF may, therefore, be subject to a relatively lower tax rate.
Did you know that the funds in RRSPs can be invested? After you've contributed to your RRSP account, you are able to invest the funds into a variety of financial products such as GICs, mutual funds, stocks and bonds (depending on the type of RRSP) to potentially grow the money that you've contributed. Since it's a tax-deferred account, taxes will be payable once you withdraw funds from the account.
3. Take advantage of the RRSP contribution limit
The RRSP contribution limit for 2020 is 18% of your 2019 “earned income” – up to a maximum of $27,230, subject to any pension adjustment. The maximum contribution limit for 2021 is $27,830.
You may want to consider maximizing the contributions within your RRSP contribution limit. The earlier you contribute and the more you contribute within your limit, the higher the potential benefits of tax deferral on income earned in the RRSP will be.
If you are beginning to plan to save for retirement, other considerations you may want to assess or keep in mind can include your tolerance for risk, your time horizon, retirement expenses and returns after-tax that you may require and inflation.
As you continue to save for your retirement, you may want to evaluate your retirement savings plan periodically as this will help ensure that you are still on track, providing the opportunity to rebalance your portfolio and make changes if needed.
4. Help recoup from any financial setbacks during COVID-19
The COVID-19 pandemic has caused many people to reevaluate goals, plans, and even their values based on the experiences of the present. As a solid financial future becomes increasingly worrisome for many, retirement planning has become more prevalent.
RRSP contributions may help towards regaining financial stability by deferring tax, while building your savings for the future.
In times of economic uncertainty, taking stock of your financial situation and future planning can have a stabilizing effect on your present and future security.
Regular RRSP contributions can build on the financial resources you currently have.
Starting to save for retirement at a younger age can help you take advantage of compound growth within an RRSP.
Although it's never too late to start saving for retirement, there are advantages for contributing to your RRSP early. Compound growth occurs when income is earned not only on the funds you contribute to your RRSP, but also on the reinvested income from those original contributions. Earnings from investments can be reinvested within your RRSP to earn additional funds over time.
Some taxpayers may be considering making an RRSP withdrawal to cover financial losses incurred by the COVID-19 crisis. It is important to keep in mind that:
- An RRSP withdrawal (except for a withdrawal under the RSP Home Buyers' Plan or the Lifelong Learning Plan), will be reduced by withholding tax.
- The amount of withholding tax varies depending on the amount withdrawn and your place of residence. The withdrawn amount will be considered taxable income in the year withdrawn.
- An RRSP withdrawal (except for a withdrawal under the RSP Home Buyers' Plan or the Lifelong Learning Plan) cannot be recontributed to your RRSP; the amount withdrawn is not added to contribution room for future years.
5. Build your nest egg with an RRSP contribution
Depending on your personal circumstances, now could be perfect to dedicate energy to making an RRSP contribution.
And while many are spending more time at home, this may also be a good opportunity to increase your knowledge about investing.
Want more details about how RRSPs work? Read Some key things to know about RRSPs.
What is an RRSP and what's different about a self-directed RRSP? Discover how investing in a self-directed RRSP may help you save for retirement and defer tax as you manage multiple investments.