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  • Self-Employed? RRSPs Are Not Just for Retirement

    February 14, 2014

    Starting a business or freelancing is the best option for many in a stubbornly shaky job market. And for others, being self-employed allows for some flextime. Entrepreneurs, farmers, independent consultants, artists, and the list goes on; it’s a brave and industrious group that makes up 16 percent of the workforce in Canada. In fact, the number of self-employed grew by 3.6 percent in the past year, accounting for more job growth than the private sector.

    Being your own boss means you are solely responsible for not only a steady income, but also for funding your retirement. Whether you’re a seasoned solo operator or just stepping into the ring, immediate day-to-day demands are often front and centre, not necessarily long-term financial planning. Yet, it’s important to consider retirement options as a central piece of your operations. For some, the business is the retirement plan. So when the time comes, the business, company, practice or farm is sold. However, the reality is that very few sales will net enough to cover retirement.

    RRSPs are still a smart way to prepare for your retirement. 

    RRSP 101

    Here is a quick review of RRSP basics; what an RRSP is and how it works.

    • An RRSP is a savings plan registered with the federal government.
    • It is a savings portfolio which can contain various types of investments.
    • The 'contribution limit' that taxpayers are given is based on income earned in a single year. 18% is the limit up to a maximum dollar amount per year.
    • When you take money out of an RRSP, you’ll be taxed on that amount.

    But for the self-employed, there is another way to consider using RRSPs beyond retirement planning.

    Smoothing out the Bumps

    Yes, RRSPs are saving plans for retirement. But they can also be used effectively for what is often referred to as “income smoothing” for the self-employed. In years of high income, you want to invest what you can into an RRSP to take advantage of maximum tax deductions. Then in years when income is lower, you can take out money from your RRSP to supplement your income.

    For example, if you earn $80,000 for a few years and contribute your maximum 18% into an RRSP each year, your annual taxable income would be reduced to $65,000. Then in leaner times, when you earn less, say $40,000, you can withdraw from your RRSP to supplement your income, while maintaining the same level of tax payable. That’s a very simple example, but demonstrates how RRSPs can smooth income year over year.

    Balancing Act

    While this is a fairly common strategy, the flip side is to ensure you’re saving enough for retirement. Income smoothing can burn through your RRSP contribution allotment so you need to strike a balance between using an RRSP to weather the light years, and saving for retirement. 

    It can be a complicated strategy that needs some careful consideration as it’s not for everyone. Essentially the goal is ensuring you have flexibility in the amount of income you have and how it is taxed both now and through retirement. In addition to RRSPs, Tax Free Savings Accounts can also be very beneficial in adding income flexibility. A Libro Coach can help you decide what savings strategies are right for you. Talk to your Coach to find out more.

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