For most people, RRSP contributions come in the form of automatic monthly payroll deductions or employer-matching programs.
Other people make lump sum contributions at the last minute right before the deadline of March 1st.
Related: RRSP Mistakes to Avoid
Whatever your style is, it’s important to make the maximum annual RRSP contribution (or at least try to).
Avoid Using the Carry-Forward Room
Annual RRSP contribution limits are based on your earned income. If you don’t make the maximum available contribution for one year, it will carry forward to the next year. This means if you don’t have the money to contribute now – you can simply wait until next year to make the contribution.
If you have $20,000 of contribution room but only contribute $12,000, the $8,000 difference will be available to use next year.
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Some people purposely avoid making the maximum annual contribution to put the money elsewhere – on a home renovation, in a Tax Free Savings Account (TFSA) or for a much-needed vacation. Since the RRSP deadline is March 1 of every year, a tropical holiday instead of a last minute RRSP contribution is tempting for many.
They believe they’ll make a large lump sum contribution in the future and avoid making the maximum contribution for now.
The problem with this strategy is that the carry forward contribution room will likely grow so big that this isn’t even realistic anymore.
For example: Joe has an annual earned income (salary) of $50,000. He has $10,000 of carry-forward contribution room. Instead of putting this in his RRSP, he takes a vacation to Europe. Each year he has an excuse not to make a contribution – a family wedding, unexpected vehicle repairs or a vacation.
Assuming his salary grows at 3% annually, by 2030 he will have $42,000 of carry-forward contribution room with a salary of only $80,000.
Contributions Create Tax Deductions
Another reason to make the maximum annual contribution is simple – it creates a tax deduction that will reduce your taxes paid for the year.
If you don’t make the maximum annual contribution in one year, you’ll miss out on the related tax deduction and will be stuck paying the full amount.
Related: The Ways We Overpay on Taxes
With a salary of $75,000 and a marginal tax rate of 32%, a contribution of $7,000 would save you $2,240 in taxes.
What’s even more important than making the maximum annual contribution is how you use your tax refund.
If you make a large lump sum contribution of $25,000 this will create a tax refund of about $8,000 (assuming a marginal tax rate of 32%). If you don’t know your marginal tax rate, click here for a quick calculator.
Related: How to Fix Tax Return Errors
Using the tax refund wisely is important because if the money is wasted, the tax deduction for the RRSP is also wasted. Here are some ideas on how to use your tax refund wisely:
- Putting the money back into your RRSP (assuming you still have contribution room)
- TFSA contributions (assuming you have contribution room)
- Paying down consumer debt (especially any debt with a high interest rate)
Less Time to Grow
The faster you put money in an RRSP and put it to work for you, the faster it will grow to a larger amount in the future because of compound interest.
If someone procrastinates about making an RRSP contribution year after year, the less time the money will have to grow – and the smaller the final amount will be.
For example: someone who contributes $2,000 annually for 30 years will grow their money to over $160,000 (assuming a 6% rate of return). On the other hand, someone who waits 10 years to start contributing $2,000 annually will have $84,000 in 30 years – almost 50% less.
I’ll admit that I’ve been a bit lazy when it comes to making the maximum annual RRSP contribution. Going forward, I plan to change that by reaching the maximum contribution limit – and then putting a plan in place to make sure I can reach it in future years.
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This means taking a look at our monthly budget and possibly reallocating more money towards savings.
Conclusion: making the maximum annual contribution isn’t achievable for most people, but the more you can contribute the better. The closer you can get to the maximum will bring you one step closer to reaching your retirement goals.
Do you make the maximum annual RRSP contribution? If not, do you plan to in the future?