As the RRSP season gets into full swing, many investors are facing a new variable that is likely to have a significant impact on their finances, with Quebec once again in a lockdown because of COVID-19. Despite the unusual situation we’ve been coping with for almost a year, making a point of contributing to a Registered Retirement Savings Plan (RRSP) offers several benefits that many investors can take advantage of.
As you know, in addition to providing a compound return that pays off in the long run, an RRSP contribution can reduce your taxable income and generate a tax refund. But the benefit varies depending on your individual situation and income, so it’s important to weigh the pros and cons.
People whose incomes have fallen significantly as a result of the pandemic may decide to take a break and wait for some normality before contributing again – without losing their contribution rights. But it may be more advantageous for others to maintain their contributions.
Reducing your taxable net income not only reduces your tax payable, but also affects the calculation of a range of tax credits and benefits, including the Canadian Child Benefit (CCB), and could, for example, lead to an increase in government grants for a Registered Education Savings Plan (RESP).
Contributing to an RRSP, even in a year of declining income, could therefore be very profitable, by reducing the effect of taxable government benefits (Canada Emergency Response Benefit, Canada Recovery Benefit and Canada Emergency Student Benefit) on income tax payable, but also by increasing the amount of the various credits available.
For example, a person who had a total annual income of $45,000 in 2020 and who received the Canada Recovery Benefit would receive a tax reduction of almost $775 for a $1,000 contribution.
In a crisis, it may be tempting to dip into your RRSP to make up for lost income. But unless your income has declined drastically since the start of the COVID-19 pandemic, doing so could have considerable tax consequences.
Depending on your income and tax situation, you’ll have to immediately pay a withholding tax on the withdrawal through your financial institution – in addition to having to pay tax when you file your 2020 income tax return – and you’ll permanently lose the contribution room you originally used.
For example, someone who earns $45,000 a year and decides to withdraw $10,000 from her RRSP to make ends meet will boost her income to $55,000, which could put her in a higher tax bracket. Tapping into your RRSP is starting to look rather costly, isn’t it?
In short, an RRSP isn’t a piggy bank. Unless you withdraw money to make a down payment on the purchase of your first home under the Home Buyers’ Plan or you do so to finance full- or part-time education or training under the Lifelong Learning Plan (both programs allow RRSP withdrawals with no penalty), it’s better to use your TFSA or other savings, or even to tighten your belt as much as possible, rather than making a move you might ending up regretting.
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