For Canadians who have no company pension plans, a combination of the Canada Pension Plan (CPP), Old Age Security (OAS) and their personal savings must be relied upon to fund their retirement years. Since CPP and OAS may only fund a fraction of retirement benefits, a large portion of a retiree's income must come from personal savings. Establishing an RRSP can support this component of a retirement plan and companies offering group RRSPs provide a convenient way to save for retirement. A group RRSP is nothing more than a collection of individual RRSP accounts. Each employee establishes their own individual RRSP that can be contributed to by way of employee and/or employer contributions.

Advantages of Contributing to an RRSP

There are essentially two significant benefits that make contributing to an RRSP a worthwhile component to your overall financial plan. The first is the immediate tax savings resulting from a contribution to an RRSP Subject to some limitations that will be discussed later, contributions made during the year and within the first 60 days of the following year can be used as a deduction from income when your tax return is filed. This deduction will result in immediate tax savings equal to your marginal tax rate, which could be as high as 48% (however this rate will vary by province and income level).

The second major benefit of contributing to your RRSP is the taxdeferred savings. The investments inside the RRSP may earn income such as interest, dividends or capital gains. However, the earnings inside the RRSP will remain tax sheltered until they are withdrawn from the plan at which time they will be taxable as income. Given that the returns are not taxed inside the plan, this allows for your investments inside the RRSP to continue to accumulate tax-free earnings that will compound the growth of the investments.

Consider this example. Eric has invested $5,000 in a non-registered investment every year, which generates a 5% annual rate of return in the form of interest income. Assume Eric has a marginal tax rate of 46% (please refer to the AIC Tax Rate Card, AIC2118 to find marginal tax rates for various provinces). After 20 years, Eric's non-registered investment after paying taxes on the interest income each year will grow to approximately $130,000, which includes $100,000 in
contributions and approximately $30,000 in after-tax savings.

Nancy on the other hand has been contributing $5,000 into her RRSP on a yearly basis and is also subject to the same marginal tax rate of 46%. Her investments inside the RRSP are also generating a 5% rate of return in the form of interest income. At the end of 20 years, Nancy's RRSP will have grown to be worth approximately $165,000 consisting of contributions and accumulated earnings. In addition to the value of the RRSP, Nancy would have also received approximately $46,000 in tax savings as a result of the annual contributions. If the annual tax savings of $2,300 were reinvested in a non registered portfolio earning the same 5% interest income, then Nancy would have accumulated an additional $59,950 after tax. Therefore, Nancy's RRSP would have grown to $165,000 plus $59,950 from her tax savings reinvestment for a total value of $224,950. This value compared to Eric's non registered portfolio will make RRSP investing worth considering.

The Rules

In order to contribute to an RRSP and enjoy the benefits, you should understand the fundamental rules so that you can maximize your planning opportunities. In particular, we will have a look at the maximum you can contribute on a yearly basis, foreign content restrictions, spousal RRSPs and finally, the benefits of having employer direct RRSP contributions.

RRSP Contribution Limits

Each year you may contribute up to 18% of your previous year's "earned income" or the maximum amount, whichever is less. The maximum RRSP contribution dollar limit for 2003 is $14,500 and will gradually rise each year. The RRSP contribution limit will increase to $15, 500 in 2004, $16, 500 in 2005 and $18,000 in 2006. Beyond 2006, the contribution limit will be indexed to increase according to the average industrial wage in Canada and therefore will be adjusted on a yearly basis. You will find your maximum RRSP contribution room on your latest Notice of Assessment or by calling the Canada Customs and Revenue Agency (CCRA).

Earned Income

So what exactly is earned income? For most people who are employees, it is simply their salary or wages before source withholdings. For self-employed
individuals, it will primarily be business income.

Earned income will also include the following items;

• Research grants, net of deductible expenses
• Royalties, if you're an inventor or an author
• Rental income (net of expenses) from real estate or from a limited partnership
• Alimony, maintenance and taxable child support received
• Disability pension income received under the CPP/QPP

Investment income such as interest, dividends, capital gains, severances, retiring allowances, death benefits and income from an RRSP or RRIF are not considered to be earned income and will not create RRSP contribution room.

Foreign Content

One of the main benefits of contributing to a group RRSP is that you may choose the investments that make up your RRSP However, you must be cognizant of some special rules pertaining to the choice of investments inside an RRSP In particular, your RRSP is restricted to invest a maximum of 30% of the cost amount of all investments in foreign property, therefore limiting your ability to diversify your portfolio. Penalties will apply to those RRSPs which exceed this threshold. For investors who wish to invest more than 30% of their RRSPs in foreign property, there are some clever methods to indirectly increase the foreign content inside an RRSP Speak to your financial advisor for more information on increasing your RRSP's foreign content exposure through RSP Funds.

Spousal RRSP's

A spousal RRSP is one in which you contribute to an RRSP for your spouse, and claim the deduction for yourself. This can be an effective method for income splitting where one spouse is currently in a higher tax bracket than the other, and can also be accomplished through a group RRSP There are essentially two significant benefits to contributing to a spousal RRSP:

o The spouse contributing to a spousal RRSP (who is in a higher tax bracket) receives a deduction for the contribution to a spousal plan, and

o The annuitant spouse (who is in the lower tax bracket) will ultimately be taxed on the withdrawals from the plan at a lower marginal tax rate, subject to certain limitations.

Any income from a spousal RRSP will be taxed back to the contributor where amounts contributed are withdrawn by the spouse in the year of the contribution or in either of the following two calendar years.

Employer - Direct RRSP Contributions - A Comparison

With a group RRSP, you may contribute to your RRSP (along with any employer contributions) directly through your pay. There are two benefits of contributing in this fashion. First, when you or your employer contribute funds directly to your RRSP, there is no need to withhold any income tax at source (although CPP and El are still payable). This allows you to nearly double the amount of your RRSP contribution if you want to since virtually 100% of you money goes directly into your RRSP. If the money is paid directly to you instead, up to 50% of the payment will be withheld for taxes with only the balance being available for contribution. Since you can afford to make a higher RRSP contribution with an employer-direct contribution your unused RRSP room can be used up sooner. As well since contributions can be made sooner, the funds can grow over a longer period of time, providing you with more money for retirement.

Figure one illustrates the benefit of participating in a group RRSP in a simple example where a lump sum payment is made to an employee. Assume Eric is entitled to receive a $10,000 bonus at the end of the year and his marginal tax rate is 46%. There are two ways Eric can contribute these funds to his RRSP. First, he could receive the bonus in cash and take the after tax proceeds and make a contribution to his RRSP The second alternative is to have the employer contribute the bonus directly into his RRSP.

In the first case, Eric receives the $10,000 bonus in cash from his employer. The bonus is subject to tax at his marginal tax rate of 46%, therefore Eric's tax liability from the bonus equals $4,600 ($10,000 x 46%). This leaves Eric with $5,400 after tax that can now be contributed to his RRSP. (For simplicity, this example does not include CPP or El source
deductions). Eric can take the after tax proceeds of $5,400 and make an RRSP contribution. At Eric's marginal tax rate, the RRSP contribution will provide tax savings of $2,484 ($5,400 x 46%).

What would happen if Eric instructed his employer to contribute the $10,000 bonus directly to his RRSP? Since the employer would not be required to withhold any taxes, the full $10,000 (less CPP and EI) can be contributed to his RRSP. At Eric's marginal tax rate, Figure one illustrates that the tax savings equal $4,600, nearly twice as much compared to the scenario where the bonus is paid to Eric. In addition, the money is contributed sooner which allows for more compounding tax deferred growth.

Figure One

You will also reap these benefits should you decide to contribute to your group RRSP at set intervals (i.e. every two weeks when you are paid from your employer). By making employer direct RRSP contributions, the tax savings are generated immediately since no tax withholdings are required. Therefore, participants of group RRSPs do not have to wait until they file their tax returns to obtain their tax savings; they receive the tax savings instantly!

The tax rules used to permit only up to $10,000 to be directly transferred to an employee's RRSP without withholding tax. This is no longer the case. Now the employer can transfer any amount up to the employee's RRSP contribution room, and not have to withhold any tax, which is a great benefit for anyone expecting a large bonus from his or her employer. In addition, this tax strategy is now even easier because you no longer need to complete the CCRA prescribed form in order to allow your employer to make this contribution.

Conclusion

RRSP's represent one of the most common and easiest ways to shelter income from tax for an extended period of time and can play an important role in achieving your retirement goals. Speak to a qualified financial advisor about your RRSP and how to reach your retirement goals.

Please Note: Canadian provinces and territories impose their own tax rates in addition to the federal tax rates. Therefore, depending on where an investor lives, that individuals tax rate may differ from any examples shown. The content of this bulletin is for informational purpose and in no way should be construed as tax advice. Please consult a professional tax advisor for tax advice related to your specific situation.