RRSP, Savings & Investments

RRSPs and Your Tax Return: The Bottom Line

Most Canadians know that investing in RRSPs is an excellent way to plan for your retirement years. By contributing to your RRSP, you are taking a step toward financial stability in your future. Who doesn’t want to have a comfortable lifestyle once you’ve left the workforce? But RRSPs also offer an immediate benefit when it comes to your tax return.

Amounts contributed to your RRSP reduce your net income. In essence, the amount of money you invest into your future by using RRSPs offers an immediate tax break. This is because RRSP contributions are entered on line 208 of your return – the section of the return used for determining your net income. The lower your net income, the less income tax you have to pay.

In example:

  • Jeff earned $65,000 last year. His payroll department did a good job and deducted the proper amount of income tax, Canada Pension Plan premiums, and Employment Insurance premiums. At this point Jeff is in a break even situation income tax wise. He neither owes nor is getting a refund.
  • If Jeff contributes $5000 to RRSPs, he is not only beginning his retirement nest egg but he will also now receive a tax refund. This is because his net income for tax purposes has been reduced by that $5000. The bottom line varies by where Jeff lives, as each province has its own tax rate. If he lives in Ontario for example, his tax refund would be approximately $1500.

There’s more good news for Jeff. The gains on his RRSP contributions are tax deferred. This means that his contributions can grow within the RRSP account and he won’t have to pay any tax on them until he draws them out. If Jeff decides to put his $5000 into a regular interest bond for example, he will declare all of his gains yearly on his tax return and those gains would be subject to income tax. By using RRSPs, Jeff won’t pay any tax on his contributions or gains until he withdraws them. Additionally, there’s a good chance that Jeff will be earning less in his golden years. If that’s the case, he will fall into a lower tax bracket and be subject to even less tax.

RRSPs also offer Jeff options before retirement. If he wants to purchase his first home, he can withdraw up to $35,000 (raised from $25,000 with 2019 Budget) using the Home Buyer’s Plan. If he wants to further his education, the Lifelong Learning Plan can help. Both of these programs allow Jeff to withdraw from his RRSPs tax-free as long as he recontributes according to Revenue Canada’s repayment schedules.

TurboTax offers a terrific tool for estimating how much of a difference your RRSP contribution will make to your tax return. By simply entering your province of residence, income, and tax deducted and then choosing a RRSP contribution amount, you can see the impact on your bottom line tax numbers.

And it’s not too late. Revenue Canada allows taxpayers to use RRSP contributions made within the first 60 days of the current year on their previous year’s return. This means that once you have determined the right amount to purchase, you still have until the end of February to make your contribution and have it factored into your tax return.