In my view, there are two great things about RRSPs. The first is the reduction in taxable income that results from a contribution. This reduces tax for most people, and allows them to leverage the tax reduction into higher savings capacity.
The other great feature -- maybe the most important -- is the annual cut-off date for contributions provides a deadline for procrastinators to make some decisions about their annual savings targets.
In the absence of such a contribution deadline, many people might still delay such decisions to take money from the spending side of the plan onto the savings side.
The deadline for contributions deductible on your 2012 tax return is 60 days after year-end, or midnight on March 1, 2013. If this deadline is missed, contribution limits carry forward to future years.
The 2012 limit is 18 per cent of 2011 "earned" income, to a maximum of $22,970, plus any unused contribution room carried forward. "Earned" income is the sum of employment, net self-employment, net rental and alimony income.
The tax benefit varies according to your taxable income, which affects your income tax rate. For example, taxable income of $20,000 means tax reduction at a rate of 25.8 per cent of the contribution (and a real incentive to consider a TFSA instead), rising to tax savings of 34.75 per cent for taxable incomes between $42,707 and $67,000. For folks with taxable incomes beyond $132,406, the saving is at a rate of 46.4 per cent.
I mentioned the TFSA, the tax-free savings account, which is a second strategy for tax deferral provided by the government.
Introduced in 2008 (with perfect timing to take advantage of the stock-market bottom), the contribution limit for 2013 has been increased to $5,500. This means the maximum to-date contributions allowed are now $25,500. This will go up to $31,000 in 2014.
The TFSA gives no immediate tax deduction. Instead, it simply provides sheltering of the investment income earned inside the plan. The huge difference between a TFSA and an RRSP is all withdrawals from the TFSA are tax-free but all withdrawals from an RRSP (or RRIF in the future) add to taxable income.
RRSP withdrawals also add to net income, the figure the government uses to calculate a range of income-tested benefits, including OAS, the Guaranteed Income Supplement, GST tax credit and a range of other credits.
So how do you decide?
If you are in the top tax bracket, the RRSP is likely your first choice, with your best strategy to then reinvest your tax saving either to pay off debt or contribute to a TFSA.
In the lowest tax brackets (up to $31,000 taxable), using an RRSP contribution is likely to save you less tax now than withdrawals will cost you down the road in retirement. For you, the better choice is likely the TFSA.
In both cases, the most important decision is to do something. Don't let the options paralyze you.
It could be that paying off debts, making needed repairs to your house or looking after your health are better choices for you.
My hope for you, though, is that you make all these decisions in the context of your overall plan.
We'll have more on RRSP and TFSA investments and decisions in the coming weeks.
Now stay warm this weekend!
David Christianson, BA, CFP, R.F.P., TEP, is a financial planner in Winnipeg and author of Managing the Bull.