While the prospect of preparing for retirement might seem challenging, Canadian tax law provides an incentive-based program that encourages that nation’s citizens to start saving early. This program, called the Registered Retirement Savings Plan (RRSP), gives Canadians two income tax benefits. One, the RRSP allows Canadians to set aside some income in a tax-free retirement account. Two, it allows individuals to lower the amount of income tax they pay each year because any contribution to the RRSP is deductible from that year’s income tax payment. Canadians refer to this lowered tax amount as the RRSP refund.
Determine the amount of money you have contributed to this year’s RRSP. You can find this amount listed on your “Schedule 1 - Federal Tax” form.
Figure out the amount of your taxable income. Take the amount you contributed to your RRSP and subtract it from the amount of income you have earned this fiscal year. The amount of income you earned this year also appears on your Schedule 1 form. The number that results from this subtraction is your taxable income.
Determine your current tax bracket. Canada taxes its citizens in five separate brackets, so to determine which bracket you fall into, take your taxable income and see where that number fits into Canada’s tax brackets. For instance, if your taxable income is $50,000, then you fall into bracket three, which covers incomes from $40,727 to $81,452.
Figure out your income tax rate. You can locate this at the Canadian Revenue Agency website. For instance, if your taxable income falls into bracket three, your tax rate is 22 percent.
Convert your tax rate into a decimal number by dividing your tax rate by 100. For example, if your tax rate is 22 percent, dividing 22 by 100 will yield .22.
Calculate your RRSP refund. Take the amount you contributed to your RRSP and multiply it by the decimal number representing your tax rate. For example, if you contributed $5,000, you would multiply $5,000 by .22 to get $1,100, which is the amount of your RRSP refund.
You can lower the amount of income tax you pay by contributing enough to your RRSP that you drop down into another tax bracket. Canada structures income tax on five income levels (or brackets), and the income tax rate differs for each bracket (so that the lowest income earners will pay less than a person whose income falls in a higher bracket). For instance, if you earn more than the cutoff line for the lowest bracket, it would make sense to contribute just enough money to your RRSP so that your taxable income then falls inside the lowest bracket. You will then only have to pay tax at that bracket’s lower rate.
According to the Saskatoon Star Phoenix, it only makes sense to contribute enough to your RRSP that you drop down into the lowest tax bracket. Any greater contribution will not provide any additional income tax reductions (although it will still provide a higher refund on that year’s taxes). Also, Canadian tax law sets limits on the amount each individual can contribute to an RRSP.
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