The 3 Questions you must ask before maximizing your RRSP contributions.

By MLD Wealth Management Team –

During tax season the industry is abuzz with reminders for you to maximize your RRSP contribution. Seldom mentioned is that when it comes time for you withdraw your RRSPs via RRIFs, that income will now be fully taxed.

To optimize the tax you will pay down the road at retirement, you need to focus on how you contribute to your RRSP on a yearly basis. The general idea here is to maximize your RRSP in the years when you’re taxed the most, and in the years when you have a low tax bill, you should avoid putting anything in your RRSP. Managing your contributions this way will help minimize overall taxes.

For any given year, ask yourself these three key questions before making your RRSP contribution:

1. How much of a tax refund will I receive on each dollar of RRSP contribution?

If you are in a high-income bracket, you will be receiving a higher tax refund (e.g., for $132,000 of taxable income, the refund is on average 44 cents per dollar). In this case, you should maximize your RRSP contributions to pay less tax now and allow those contributions to grow tax-free until you retire.

2. How much will I pay in taxes when I take money out of my RRSP/RRIF?

If your income is lower in a particular year, then your tax bill for that year will be relatively small. If you maximize your RRSP contributions every year in this situation, then you are merely creating a higher tax bracket for your future self. Determine what your tax bracket will be in your RRSP/RRIF years, and if this is higher than your current tax bracket, then consider holding off on that RRSP contribution.

3. How much time will the RRSP be able to grow tax-free?

Currently, you can contribute to your RRSPs until you reach 71 years of age. After that, you are required to make withdrawals via a registered retirement income fund, and the government enforces certain minimum withdrawals depending on your age. As a general rule, the younger you are, the more you will benefit from long-term tax-free growth, so you should maximize your RRSP contributions where possible. However, if you earn less than $40,000 per year (similar to question 2), consider alternatives like a Tax-Free Savings Account.

Remember, optimizing your RRSP contributions depends on your individual situation, and things can change from year to year. A trusted financial advisor can explain your options and help you make the most of these tax minimization strategies.