Is the late rush to top up an RRSP account worth the trouble?

Every year many (even most) eligible Canadians wait until the deadline to contribute to their Registered Retirement Savings Plans.

This year, that deadline is March 2 to make your 2019 contribution to benefit from the resulting tax deduction for the past year.

The deduction limit for 2019 is the lesser of 18 percent of your 2018 earned income or $26,500. So if you earned $100,000 in 2018 your deduction limit would be $18,000, not $26,500. You would have had to earn about $147,200 in 2018 to qualify for the maximum deduction.

The deduction limit is indexed and rises annually to approximately reflect the rate of inflation. In 2013, for instance, the deduction limit was $23,820. Interestingly, one Canadian bank estimates that over the last decade Canadians had about 85 percent unused contribution room compared to what they were entitled to contribute to their RRSPs.

But is the February dash to top up your RRSP the best investment strategy? Not really.

If you had taken the same amount and divided it into monthly installments from March 2019 to February 2020, the potential capital gains growth and dividends provided within your RRSP investment portfolio plus the compounding effect on such growth would have given you significantly more bang for your buck.

Another interesting development is that Tax-Free Savings Accounts (TFSAs) are becoming more popular than RRSPs. A different Canadian bank estimated that 2019 was the first year more Canadians had TFSAs than RRSPs, coming in at 57 percent versus 52 percent. Unusually, however, most TFSA holders seem to treat the instrument as a savings account rather than an investment vehicle like RRSP holders. If you invest wisely, the potential gains are much greater than just holding cash.

What are some of the differences and benefits to the two structures?

Some would say that RRSPs are less beneficial than TFSAs in that the former is just a tax deferral system that will still require you to pay the taxes on withdrawal of the funds. True, but those funds can grow sheltered from tax until you are ready to withdraw them and you get to reduce your annual tax load through the deductions your contributions allow you to take. That gives you the ability to use your greater income as you see fit rather than government using your money as tax income.

As well, you get those deductions when you are most likely in a higher tax bracket but with an opportunity to pay the taxes on withdrawal at a lower tax bracket rate.

TFSAs are funded with income on which you have already paid taxes so you can withdraw from the account at any time tax free. You also have the ability to return funds withdrawn from your account, which can be added to your annual contribution limit of $6,000 in 2019 with certain constraints on the timing of such deposits. Any unused portion of your contribution limit in previous years can also be added to your contribution this year.

One common element between RRSPs and TFSAs are the penalties for contributing in excess of your entitlements — they can be painful.

Grant Diamond is a tax analyst in Saskatoon, SK., with FBC, a company that specializes in farm tax. Contact: fbc@fbc.ca or 800-265-1002.

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