RRSPs: Contributing - Part 1
Because of the tax benefits provided by RRSPs, the Canadian government has capped the amount of money that can be contributed. (Note: the contribution limit is sometimes called the deduction limit). For the 2010 tax year, the Canadian government will allow people to contribute 18% of their yearly earned income, or a maximum of $22,000 (whichever is the lesser amount), to their RRSPs.
If Brad makes $35,000 per year, the maximum amount of money that he is allowed to contribute in the 2010 tax year is the lesser of $22,000 or ($35,000 x 18%). Because 18% of $35,000 is equal to $6,300, the maximum that Brad is allowed to contribute in the 2010 tax year is $6,300, assuming that he has not carried forward any contribution room from previous years (we will get into this later).
Brad\'s wife makes much more money than Brad does. She makes $150,000 per year. In the 2010 tax year, her maximum RRSP contribution will be the lesser of $22,000 or ($150,000 x 18%). Because 18% of $150,000 is equal to $27,000 (greater than the $22,000 ceiling), Brad\'s wife is only allowed to contribute a maximum of $22,000 for the 2010 tax year.
Earned Income Defined
For many people, earned income is simply another term for salary. However, it is important to understand that there are many rules governing just what is and what is not counted in an RRSP contributor's earned income. Depending on your particular situation, determining your earned income can be quite complicated. Here is a detailed view of the earned income calculation:
||=||Salary Earned from Employment|
|+||Net Income from Self Employment|
|+||Net Income from Active Business Partnerships|
|+||Research Grant Money (Net of Expenses)|
|+||Rental Income (Net of Expenses)|
|+||Taxable Alimony & Maintenance Payments Received|
|+||Taxable Child Support Payments Received|
|+||CPP/QPP Disability Pensions|
|-||Deductible Alimony, Support & Maintenance Payments Paid|
|-||Losses Incurred from Ownership of a Rental Property|
Fortunately, the government does this calculation for you. You can find it on your notice of assessment (NOA), which we'll discuss later. However, most financial professionals recommend double-checking the figure provided by the government. If you aren't confident about doing this calculation yourself, your accountant can certainly help. A computer-based tax program may also be able to do the calculation for you.
When and How Can I Contribute?
Contrary to popular belief, RRSP contributions are not made only in February. Although February is the time when the big Canadian banks go on an advertising blitz, you can contribute to an RRSP on any business day throughout the entire year. The actual act of contributing is no more complicated than transferring money from an existing account or writing a check. Talk to your institution about the particular options that are available for making account contributions.
Be aware that contributions for the current tax year can be made until March 1 of the following year. For example, if you were trying to claim a deduction for the 2010 tax year, you would have to make a contribution by March 1, 2011. A contribution on March 2, 2011 would have to be claimed on your 2011 tax return.
What Happens If I Contribute Too Much?
The Canadian government lets everyone contribute $2,000 more than their individual lifetime contribution limit without penalty. The $2,000 overcontribution allowance is not an annual allowance, but a lifetime maximum. You can overcontribute $40 one year and $50 the next, but if your total lifetime overcontribution adds up to more than $2,000, you'll be penalized heavily with a 1% tax on the amount over $2,000 each month. This will continue until your next notice of assessment comes out, when you will be eligible to contribute your usual amount - less the amount over $2,000 of your previous overcontribution.
What If I Can't Make the Maximum Allowed Contribution?
If you don't max out your RRSP contribution (and most Canadians either don't or can't), you don't lose this contribution room. Any unused contributions are carried forward to your future deduction limit.
Suppose that this year, your maximum allowed contribution is $5,000, but you only invest $2,000. Next year, you're allowed to add the $3,000 you missed to your maximum allowed contribution for the next year or in any year until you turn 69.
|Maximum Allowed Contribution||Amount Actually Contributed||Amount Allowed to Carry Forward to Contribute Another Year|
The government adds up all the contribution room that a person misses in a lifetime, and these funds can be contributed at any point, even all at once. So if you've never contributed to an RRSP, a good estimate of the amount of room you have is 18% of all earnings you've ever made. Better yet, you can find the exact deduction limit on your notice of assessment form, which the Canada Revenue Agency will send out with your income tax forms.
If you're not sure where you can find that form, contact your nearest Canada Revenue Agency office, and someone will be able to answer any questions you may have regarding RRSPs.
RRSPs: Contributing - Part 2