Written by Christopher Liew, CFA at The Motley Fool Canada
Successive rate hikes due to stubborn inflation have altered retirement timetables. While it’s difficult to save while coping with the higher cost of living, Registered Retirement Savings Plans (RRSP) users should continue their contributions. The tax-deferred investment account is worth using to build retirement wealth and secure one’s financial future.
Besides realizing significant tax deductions, RRSP contributions compound tax-free resulting in higher payouts. Let me share the secret and some tips on how some RRSP users manage their accounts effectively and maximize the incredible benefits.
The secret to success
The secret that leads to success and holds to the present is contributing early to the RRSP, especially if you have a longer time horizon. Also, the best strategy is to contribute at the beginning of the tax year and not wait for the end of the tax year, which many do.
The Canada Revenue Agency (CRA) sets annual contribution amounts every tax year and allows the carry-over of unused contribution rooms. Because of this feature, you can easily catch up in case you can’t maximize the yearly limit or allowable contribution.
If your finances won’t allow you to contribute the maximum, make smaller, regular deposits each month but far from the deadline. Your RRSP balance should compound faster the more time you save and invest.
For the 2023 tax year, the RRSP deadline is February 29, 2024. You can contribute 18% of your previous year’s income or $30,870, whichever is lower. The CRA allows over-contribution of $2,000 or less but will charge a 1% per month penalty if you retain an excess of more than $2,000.
An RRSP user can hold bonds, ETFs, GICs, mutual funds, and stocks in the account. All earnings from these income-producing assets are tax-free while they remain in the plan. If you want to unlock the full power of your RRSP, consider holding shares of Bank of Nova Scotia (TSX:BNS) and Whitecap Resources (TSX:WCP).
Given the average yield of 7.105%, the combo should deliver higher dividend income. The Big Bank pays a lucrative 7.55% dividend, while the energy stock yields 6.66%. There should be no payout interruption within the year as BNS pays every quarter, while Whitecap’s payout frequency is monthly.
BNS, Canada’s fourth-largest bank ($67 billion market capitalization), has a dividend track record of 191 years. Whitecap Resources, a $6.7 billion oil-weighted growth company, boasts a fantastic 372% return in 3 years. If you invest today, the share prices are $56.19 and $11.05, respectively.
Assume an equal allocation per stock of $15,345. The investment transforms into a quarterly and monthly dividend of $291.34 and $85.66, respectively.
More helpful tips
The RRSP has helped many achieve their long-term financial goals, although saving for retirement using the account requires discipline and resolve. A future retiree’s mindset should be to save and invest first, not spend.
Don’t be tempted to make early RRSP withdrawals because your money stops compounding, and you pay hefty withholding taxes. Moreover, the CRA won’t give back the lost contribution room. Savvy users will even use their tax refunds to make RRSP contributions and top up their investments to fully maximize the tax benefit.
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