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Feeling boxed in by your RRSP?

We often hear that Canadians aren’t contributing enough to their RRSPs. Unfortunately, some people simply are not allowed to contribute more! But, there are solutions to the problem.

RRSP can be simpler in theory than in practice, starting with the amount you are allowed to contribute to your plan every year.

In theory, you may contribute 18% of your previous year’s earned income (to a pre-established maximum), plus any unused contribution room. That’s pretty simple. In practice, however, the 18% also includes retirement savings in a registered pension plan (RPP) or a deferred profit-sharing plan (DPSP). If you are a member of such a plan, you must consider your pension adjustment (PA) when determining your RRSP contribution. Otherwise, you may overcontribute and incur penalties.

What is the pension adjustment?
The pension adjustment (PA) is the value assigned to the contributions made or benefits accrued by a member of a registered pension plan (RPP). The calculation formula depends on the type of plan.

In a defined contribution plan, the PA is equal simply to the contributions made to the plan by the employer and the employee. For example, if you earned $70,000 in 2014 and your RPP contributions were $6,600, your RRSP contribution room would be as follows:


Earned income

Contribution room before PA


PA


Contribution room

$70,000

x18%=

$12,600

-

$6,600

=

$6,000

In a defined benefit plan, the PA is linked to the value of the annual accrued benefit and is calculated according to a formula established by the Income Tax Act (this formula may vary for some plans, notably for a CARRA plan (only in French)): PA = [9 X (annual accrued benefit)] - $600

Employers must calculate a PA for every pension plan member and enter the amount on the employee’s T4 slip. If the PA is lower than the employee’s contribution room, the employee may contribute the difference to an RRSP. Otherwise, there is no more contribution room. Sounds simple. But wait.

Two more PAs

Two other concepts enter into the picture: the pension adjustment reversal (PAR), and the past servicepension adjustment (PSPA). The PAR applies to an employee who terminates membership in an RPP and receives a termination benefit lower than the sum of all post-1989  pension adjustments; the PAR thus restores the individual’s contribution room. The PSPA arises in a determined benefit plan in conjunction with a “past service event” that causes a member’s post-1989 benefits to increase. For example, if your plan was amended so that you are credited with additional pensionable service, you will have a PSPA.

For more information on the pension adjustment, visit the Canada Revenue Agency website.

Investment strategies for dealing with the PA

So how do you save with limits like these?

TFSA


A 
Tax-Free Savings Account (TFSA) is the ideal complement to an RRSP, and can sometimes even be a substitute for one, since it shelters your investments from taxes and has no associated pension adjustments. Of course, contributions are not tax deductible, but withdrawals are not taxable and they are not included when calculating Old Age Security benefits. You may deposit up to $36,500 in a TFSA for the years 2009 to 2015.

Read our article Three ways to benefit more from your TFSA

An investment account

You can also consider other options according to your situation…

RESP
You might also consider a Registered Education Savings Plan (RESP), which allows you to save money for your children’s (or grandchildren’s) education in a tax-sheltered account, and also entitles you to generous grants. When the child registers for post-secondary studies, he or she can receive educational assistance payments (EAP) made up of the grant money and accumulated gains in the account. EAPs are taxable for the student at what is likely to be a very low rate, if any tax is payable at all. As for you, you may recover your contributions tax-free and use them for whatever you like, such as retirement.

Pay off your debts

Another way to deal with the PA is to do something about the other column on your balance sheet, i.e. your liabilities. No longer having to pay interest on an outstanding debt is like earning the equivalent return on an investment. In fact, it’s even better, since most of the interest we pay on our debts is not tax-deductible, while most of the returns on our investments end up being taxable (except in a TFSA). For example, paying off a debt that bears 5% interest is like getting a pre-tax return of 10%, assuming a 50% marginal tax rate on the investments.

If you have any questions about your RRSP, the impact of your pension adjustment and savings strategies that could help, contact a Services d’investissement FÉRIQUE mutual fund representative!