If you are fortunate enough to have kept your job throughout the pandemic and even received a bonus for 2020, count yourself lucky.
After a year of being told all the things you can’t do, the impulse to take your bonus on a spending spree would be completely understandable.
Yet before you whip out your credit card, take a moment to consider embracing your good fortune as an opportunity to top up your registered retirement savings plan (RRSP).
Contributing your bonus to your RRSP will help supercharge your retirement savings, setting the stage for much bigger rewards in the years ahead. And just as importantly, it will help you create something positive out of such a horrible year.
The 60-second RRSP refresher
What is it?
An RRSP is a powerful investment tool that delays the timing of when you pay income tax. This may not sound significant, but the impact on your finances can be huge.
How does it work?
Directing your bonus to your RRSP allows you to invest pre-tax income, separating it from your taxable income before the government takes a big bite out of it. As the investments within your RRSP account grow over the years, any dividends, interest, and capital gains that they accumulate are not taxed.
How does this help me?
By starting with a larger pre-tax amount and avoiding tax deductions as it grows, your RRSP has the potential to grow much larger compared with investments made over the same period that are not tax-protected.
Reap the rewards of a tax-protected investment
The graph below illustrates the difference between contributing a bonus of $10,000 towards your RRSP vs. getting your bonus in cash (taxed at 47%). In both cases, we assume a growth rate of 5% per year.
As the graph shows, putting your bonus into your RRSP can help you reap significant rewards over the long term.
Follow the rules or pay a price
To take advantage of the great benefits offered by RRSPs, you need to play by the rules. This means staying within the contribution limits.
For the 2021 RRSP season, individuals are allowed to contribute up to 18% of their income or $27,830 – whichever is lower.
Keep in mind:
Some factors can reduce your contribution limit (e.g. contributions made to your employer’s pension fund)
Some factors can increase your contribution limit (e.g. unused contribution room from a previous year)
You can find your contribution room for 2021 on your latest notice of assessment from CRA. If you can’t find your NOA, you can call your accountant and/or CRA.
In general, withdrawing funds from your RRSP before you retire will result in a considerable penalty, so this is something to avoid unless absolutely or strategically necessary.
There are exceptions when early withdrawals are allowed – such as to pay for education or buy a house – but these withdrawals must meet specific criteria. To ensure you don’t accidentally break the rules, it’s always a good idea to consult your financial advisor before withdrawing.
Don’t miss the deadline
Timing is also critical when it comes to your RRSP. To be counted by CRA as an RRSP contribution for the 2020 tax year, it must be made by 1 March 2021. If you miss this deadline, you’re out of luck.
This means that if you want to put your 2020 bonus to work in your RRSP, you need to take action now:
Speak with your financial advisor about how to use your bonus to maximize the value of your RRSP
Determine your RRSP contribution room
Check with your employer for any internal deadlines for directing your bonus towards your RRSP (this may be earlier than the CRA deadline)
Today’s opportunity, tomorrow’s windfall
If you’re a working professional with a high income, maxing out your RRSP contribution is almost always the right decision. And if you are among the lucky ones to come away from 2020 with a bonus, now is your chance to move forward with some lasting good from a year to forget.
If you would like help optimizing your RRSP or would like to discuss other complementary strategies within an overall financial plan, Rubach Wealth can help. We invite you to contact us at info@rubachwealth or 647.808.7700 to discuss how acting now can give you so much more to be thankful for in the future.