Hooray! Tax season is over and with that comes your refund (if you’re fortunate) and notice of assessment. Check out my last video for what you should be doing with any tax refund you received from the government here. In today’s video, I’ll be discussing an important and potentially confusing piece of your notice of assessment, the RRSP deduction limit statement. I’m Susan Daley and this is Your Money, Your Choices.
If you’re like me, you’ve gone paperless when it comes to taxes so your notice of assessment and other tax information are online through CRA’s MyAccount. This makes it easy to look up how much you’re allowed to contribute to your TFSA and RRSP, based on CRA’s limits and your past contributions. But beware, your RRSP Deduction Limit is not your contribution room (i.e. how much you are allowed to put into an RRSP).
The RRSP deduction on the other hand is how much of that contribution you have used on your tax return to reduce your income for tax purposes. Typically these two numbers are the same, but they don’t have to be. It is acceptable to make a contribution to your RRSP, and save the tax deduction for future years. There are a few reasons why someone might not want to deduct their RRSP contribution from their taxes in the same year they made the contribution. Say you have lots of contribution room and you just received an inheritance, of which $50,000 you want to contribute to your RRSP. Let’s say your income is $120,000 in Ontario, so you’re in the 43.41% tax bracket. If you deducted your total contribution from your taxes that same year, your tax bracket would drop to 29.65%. You’d get a total refund of $19,372.36 come tax time. If instead, you decided to split the tax deduction over two years and only use $25,000 in tax deduction each year, you’d get $10,852.50 back for each of the two years, or a total of $21,705. Assuming you invested the $50,000 plus any tax refund immediately, you’d have to earn an investment return of 27.38% over the year to be in a better position making the total deduction in the first year, rather than spreading it out. Putting that $50,000 directly into your RRSP right now will ensure that any earnings on that contribution are tax free immediately, but you can pick and choose when you want to deduct that from your taxable income and receive your tax refund.
Another possibility is that you are in a situation where you are in a low income tax bracket at the moment, but you expect to earn more in the near future and be bumped into a higher tax bracket. Waiting to deduct the contribution amount allows you to get the savings in the RRSP quickly so it can start earning investment returns tax free, but receive a higher tax break when your income is higher. For example, say you’re earning $50,000 right now and you want to contribute $10,000 to your RRSP. Next year, your income will be $100,000. Delaying the income tax deduction by one year will cause your tax refund to be $1,791.62 higher, and your one year return would have to be over !!70%!! to be in a better position using and investing the value of the tax deduction immediately. These are some uncommon examples, so if you’re considering delaying your RRSP deduction, make sure you run the numbers first to ensure you’re leaving money on the table by investing more immediately.
If you are in the situation where you haven’t claimed all your past RRSP contributions on your tax returns, your deduction limit will be different than your available contribution room. The deduction limit is how much you could potentially deduct from your tax return in the given year. It includes the amount of contributions you have deferred to use on future tax returns, called Unused RRSP Contributions, and how much you are allowed to contribute for the current year. I repeat, this is not your available contribution room. Deduction Limit = Unused Contributions + Available Contribution Room.
It’s important to know what your available contribution room is so that you don’t overcontribute and incur hefty penalties from the CRA.
Here’s an example: Say you had an RRSP deduction limit for 2017 of $25,000, and you had Unused RRSP contributions of $5,000. This would mean that you are only able to contribute $20,000 to your RRSP in 2017, not the $25,000 deduction limit.
The confusion between deduction limit and contribution room can be problematic for those that login to their CRA MyAccount and select the RRSP section, which only shows the Deduction Limit and Unused Contributions. In order to be sure of what you can contribute to your RRSP and stay within the limits, you’ll have to open up your notice of assessment and look for “available contribution room for 2017”.
In summary, there are instances when your RRSP deduction limit and RRSP contribution room will be different, which can beneficial for your finances. However if this is the case, be sure to only contribute up to your available room, otherwise the penalties will eat into any potential gains of deferring your RRSP deduction.
