As the holiday season draws near, many of us will start thinking about what kind of gifts to buy for our loved ones. Few will think about how much they should be contributing to their RRSP. But before frenzied shopping has depleted our bank accounts, now is probably a good time to make an RRSP contribution.
How much is enough?
This of course raises the question, how much should I contribute? As with many things in finance, the answer depends on several factors. Do you currently have automatic payroll deductions set up? And if so, how much as a percentage of your salary have you been contributing so far? Many financial planners advise individuals to set aside no less than 10% (others recommend 15%) of their salary for retirement savings. So let’s say for example Andrew is an employee earning $60,000 a year and has been contributing $400 every month this year and is therefore on track to contribute a total of $4,800 in 2019. Since 10% of Andrew’s salary is $6,000, this means he is due to have a shortfall of at least $1,200. This can be made up by making additional contribution/s before the RRSP deadline on March 2, 2020.
The math however, is not always that simple. The 10% minimum guideline assumes someone has been contributing consistently early on in their career and would continue to do so until they retire in their 60s. If you haven’t been contributing that much in the past or have had extended periods of time when you were unemployed, you may need to raise your contributions well beyond 10%. If your employer offers you matching contributions, that should lighten the burden to a degree. The Open Access Retirement Calculator can provide contribution recommendations more customized to your situation.
Always remember that guidelines such as the minimum 10% contributions are just that, guidelines. People have widely varying outlooks for retirement and depending on your personal situation, the 10% ‘rule’ may not apply. Life expectancy and desired lifestyle in retirement are factors you should certainly consider when determining how much you ought to contribute. And even if you are unable to contribute 10% or more, remember that any contribution can make a difference in the long-term.
RRSP Contribution limits
To be on the safe side, it’s always advisable to raise your contributions beyond the recommended minimum. Your future self is quite unlikely to begrudge present-day you for over contributing during your working life. On the contrary, having a financial cushion in retirement can reduce stress and leave you with more opportunities to enjoy your golden years.
At the same time, remember that there is a limit on the amount you are able to contribute each year. This is 18% of your earned income from the previous year up to a certain cap ($26,500 for 2019). Note that employer contributions count towards your limit. Fortunately, if you have not been maxing your RRSP contributions in the past, your unused contribution room can be added to your current limit.
Contributing to your RRSP before the deadline can have a material impact on your tax return. By reducing your net income on the tax return, RRSP contributions effectively put you in a lower tax bracket. For instance, if you earned $60,000 in 2018 and assuming your payroll department correctly deducted your income taxes (putting you in a break-even situation), a $6,000 RRSP contribution would provide you with a tax refund of $1,779.
While the short-term benefit of contributing to your RRSP can be quite material, the long-term gain is even more so. When you set aside money in your RRSP, it will grow in a tax-sheltered environment until you withdraw it. To put this in perspective, a one-time contribution of $10,000 placed in an investment yielding average annual returns of 6% will grow to be $32,071 in twenty years. This is without factoring additional contributions during that time period. Such is the power of compound growth!
For those of us without access to a Defined Benefit pension plan, an RRSP is a great saving vehicle with many incentives designed to help us maximize the size of our nest eggs. Setting up automatic payroll deductions is perhaps the most effective RRSP strategy as it gives your contributions more consistency and discipline. However if you fell short of your desired contributions this year, now is the time to make up the shortfall.
As a group retirement plan provider, Open Access is changing the way retirement plans are run by unburdening employees from the need to make investment decisions on their own and instead managing portfolios on their behalf. We do this as a fiduciary, meaning no proprietary products, zero conflicts of interest, and no hidden fees.