How Does an RRSP Contribution Reduce Your Income Tax?

Here is a simple example to help explain.

Joe: Annual Salary:  $50,000

Income Tax Paid:   – $11,036

After-Tax Income:    $38,964

An allowable RRSP contribution can be deducted From your income.  In other words your income will be lower when calculating how much income tax you owe for the year. If your income is lower then the income tax owing would be lower too.

To make this clear, let’s say Joe Salary makes a contribution of $5000.00 to his RRSP. Since this amount can be deducted from his income, his income would be $45,000.

Annual Salary:       $50,000

RRSP Deduction:  – $5,000

Taxable Income:    $45,000

Income Tax owing on $45,000 is $9,194.

Remember Joe paid, $11,036 for someone earning $50,000.

Therefore if we take what Joe paid $11,036 and subtract what he owes $9,194…

Income Tax Paid:  $11,036

Income tax Owing: – $9,194

Tax Refund of: $1842

Note: The numbers used are taken from 2016 income tax table’s published in the Financial Advisor’s Pocket Reference by Wolters Kluwer.

Remember an RRSP is an income deferral vehicle. Keep in mind that down the road, monies withdrawn from an RRSP are subject to taxation as earned income.

2017 RRSP deadline is Wednesday March 1st.

There are contribution limits on RRSPs, 2017 Contribution Limit $26,010. Your allowable RRSP contribution for the current year is the lower of:

• 18% of your earned in- come from the previous year, or
• The maximum annual contribution limit for the taxation year, or
• The remaining limit after any company sponsored pension plan contributions.

Earned income includes salary or wages, alimony received, and rental income, among other income sources, but does not include items such as investment income.

To find out the exact amount you can contribute to your RRSP for the current year, check on your most recent the Notice of Assessment you received from Canada Revenue Agency.

source: Luigi DiCamillo – HUB Financial Inc.