With the RRSP contribution less than one day away, I thought I would post some common RRSP myths out there.
Most people know that you need to make a contribution in order to get the deduction on your taxable income, but what many people don’t know is that you do not need to contribute cash towards your RRSP.
This concept and some other common RRSP myths are discussed below.
Myth: You must claim the deduction on all RRSP contributions each year
Most people automatically assume that just because they made an RRSP contribution that they must report it on their tax return. This is not true.
The easiest way I remember it is that the government is actually losing out on tax revenues when you report an RRSP contribution, so why would they be in a hurry for you to claim it?
The truth is that they’re not. They don’t care if you report it now or in future years.
Related: How Does CRA Decide Who to Audit?
While it is true you need to report the contribution that you made, you do not need to claim the deduction.
It should be noted that it would only make sense to defer a deduction if you knew you would have a significantly higher taxable income in a future year.
For example, if you had a large capital gain to be claimed in a future year it may make sense to defer a deduction (all other things being equal)
Myth: You need cash to contribute to an RRSP
RRSP contributions can be made ‘in kind’ – which means no cash involved. Investments can be transferred from a non-registered account to an RRSP and still qualify for a deduction on the amount of the contribution.
It is important to note that the transfer of any investments (such as equities) is done at current fair market value. This may trigger a capital gain if the current price is higher than the cost. Taxes would need to be paid on the capital gain, but you cannot claim any capital losses on in-kind contributions.
For a non-registered account you’d be better off to sell the investment beforehand, record a capital loss for that year and then use the cash as a transfer.
Just remember to not buy back the same stock within 30 days in your RRSP, as this is considered a “superficial loss” and is not allowed by CRA.
Myth: You cannot open an RRSP until you turn 18
Unlike a Tax Free Savings Account (TFSA), which can be opened by anyone over the age of 18, an RRSP can be opened by anyone at any age.
Some people have children who work part time but don’t earn enough income each year to be taxable. In this case many people wouldn’t bother filing a tax return for the children because they would not be taxable because of their low income.
This is probably true for most, but filing a tax return would allow them to create RRSP contribution room by reporting earned income. The children could earn low amounts of income for years and pay little taxes (or none at all), but still generate RRSP contribution room.
This situation would be ideal for students who work part time but are not taxable. When they graduate and start to earn more by working full time, they will have more RRSP contribution room from prior years.
Myth: An RRSP is converted to a RRIF at age 65 and is fully taxable
Most Canadians understand the basics of an RRSP but many don’t understand the rules of converting it to a Registered Retirement Income Fund (RRIF).
A RRIF is similar to an RRSP in that the funds are held tax-free but the opposite in that you cannot add amounts – you must withdraw amounts from a RRIF using a percentage specified by the government each year. CRA has a schedule of percentages outlining the minimum withdrawal amounts that are based on the total value of the RRIF.
What many don’t realize is that you have until December 31 of the year you turn 71 to convert your RRSP to a RRIF. When it is converted, the funds are taxed when they are withdrawn (just like an RRSP).
The main difference between a RRSP and a RRIF is that with a RRIF, the government specifies the minimum percentage to be withdrawn each year (there is no maximum) and you cannot add to a RRIF, it only gets smaller.
Minimum withdrawals on a RRIF must start when someone turns 71 only if that person is single. If the person is married and their spouse is younger, the minimum withdrawals can start when the younger spouse turns 71.
For example, if I turn 71 and my wife is still 67, I can wait until she turns 71 to start the minimum withdrawals.
Conclusion: there are many misconceptions about an RRSP but some of the biggest ones are: (1) you need cash to contribute, (2) you need to be 18 to open an RRSP, (3) an RRSP is fully taxable when converted to a RRIF at 65 years of age.