How much can I put into my RRSP? Calculating your RRSP deduction limit

As you probably already know Canadian RRSPs are a great way to lower the taxes you have to pay. My clients often ask me, “How much of net income should be put in retirement savings”? My answer is usually the same, as much as you can afford. Why? Because I believe one of the greatest ways to accumulate wealth occurs when you remove tax effects and allow for compounding interest and capital growth to accelerate tax free. With this philosophy the question of how much of net income should be put into RRSPs often changes and becomes How much can I put into my RRSPs?

The amount you can put into your RRSP is limited by your unused RRSP deduction room. Each year that you earn income you increase the amount of room available of your unused RRSP. So if you have been working for 20 years and have never contributed to your RRSP then you most likely have a very large amount of room to make RRSP contributions in the current year. This is because Unused RRSP deduction room can be carried forward indefinitely.

The actual calculation of RRSP room that you gain each year is derived from taking 18% multiplied by your current years earned income. Earned income is slightly different than net income and is calculated as follows:

1. Employment income before deduction of RPP contributions
2. Income from royalties in respect of a work or invention
3. Rental income
4. Income from carrying on a business either alone or as a partner
5. Alimony

Less:

1. Business losses from the carrying on of a business, either alone or as a partner actively engaged in the business 2. Rental losses
3. Alimony or maintenance payments deducted

Earned income is calculated as a base rate to apply the 18% to in order to derive your current year allowable deduction amount. In addition there is a maximum deduction amount allowable for each year. Maximum deductions for 2007 are as follows:

The lesser of:

a) actual contributions
b) (18% x 2006 earned income) - (2006 PA)
c) $19,000 - (2006 PA)

The pension adjustment (PA) is a calculation of the pension benefit earned during the year. Unused RRSP deduction room is calculated as the difference between the RRSP deduction limit (the least of (b) and (c) above) and the actual contribution ((a) above)

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