RRSPs and TFSAs have a mysterious, almost scary aura. Little understood by non-finance types, the investment vehicles are hugely important to retiring at all, let alone retiring early. Luckily, if you want to max out your RRSP and TFSA, it’s really simple (although incredibly difficult without strong financial discipline).
Step 1: How much money do you make? If you earn a salary, this should be a relatively straightforward number, say $50,000. However, if you make an hourly wage, calculate an approximate wage, say $15/hr x 40 hours per week x 50 weeks in a year ($30,000).
Step 2: Calculate 18% of your yearly earnings. For a person making $50,000, this amount works out to $9,000. For a person earning $30,000, this amount is $5,400. Whatever your amount is, that’s your maximum RRSP contribution (as long as it’s under $26,010 which is the absolute maximum in 2016). This ignores workers who have pensions through work but the majority of Canadians don’t so let’s ignore those lucky few who do.
Step 3: Add $5,500. In 2016 the maximum amount you can add to a TFSA is $5,500. This number is indexed to inflation and can be changed at the whim of the federal government so if you’re reading this guide in the future, double check the amount!
Step 4: This number (the RRSP maximum added with the TFSA maximum) is your savings goal. This number is the amount that you must save every year in order to max out your RRSP and TFSA. If you’re paid monthly, divide this number by 12. If you’re paid bi-weekly, divide this number by 26. This new, smaller number is the amount you must put contribute to you RRSP and TFSA each pay period.
Let’s say I earn a salary of $70,000 and I’m paid monthly.
Step 1: $70,000
Step 2: $12,600
Step 3: $12,600 + $5,500 = $18,100
Step 4: $1508.33/month
The fun part about contributing to your RRSP is that you defer taxes. Tax deferment is a fancy way of saying that you save on taxes today, but have to pay them in the future. In the above example, I’ve contributed $12,600 to an RRSP so, at tax time, I will only have to pay taxes on the difference between my salary and the RRSP contribution: $70,000 – $12,600 = $57,400.
So, instead of paying $15,293 in federal and Alberta taxes, I would only have to pay $11,450.
Let’s Keep Going
Without contributing to an RRSP and a TFSA and paying $15,293 in taxes, a person earning $70,000 would tax home $4,558.92 each month after taxes. With contributions though and a lower tax bill, a person earning $70,000 would take home $4,879.17 but would have to put the $1,508.33 we calculated above into his RRSP and TFSA. This reduces his take-home pay to $3,370.84.
Help Me I’m Poor
Yes. Yes you are. It definitely seems like a lot of money to “lose” each month but in reality, you’re coming out ahead. In our example, you might be taking home $1,200 less each month but you’re investing $1,500 each month. You’re literally keeping an extra $300 a month or $3,600 a year from the government’s coffers.
What’s more, that money you’ve put aside will compound and grow to provide a hefty nest egg when you decide to retire.