This article will review some concepts that Canadians can utilize to maximize their Registered Retirement Savings Plan (“RRSP”) contributions.
As a quick refresher, a RRSP is type of account in which contributions reduce taxable income and investment earnings grow on a tax-deferred basis.
Here are three strategies that can optimize your RRSP:
Reinvesting your tax refund
One of the many reasons Canadians contribute to a RRSP is to receive a refund on their tax return. One strategy that will immediately augment your RRSP is to deposit that aforementioned tax return back into the account.
RRSP Loans
If you are in a particularly high-income earning year and want to make a sizeable RRSP contribution, but do not have available capital to do so, one avenue to explore is a RRSP loan. The premise here is you contribute the loan into your RRSP, and use the tax refund to repay a portion or all of the loan. The specifics will vary on contribution room, marginal tax rates, and interest rates. This should be carefully considered prior to executing.
RRSP Gross-Up
The RRSP Gross-up is a continuation of the prior strategy mentioned above and involves an additional layer of complexity. To execute this strategy, you will borrow an amount equal to the expected tax refund prior to the contribution and use the realized tax refund to repay the loan. Here is an example using the Gross-up formula:
(RRSP contribution amount x marginal tax rate) / (1 – marginal tax rate) = Gross-up amount to borrow
If you had $10,000 to contribute and were in a 40% tax rate, here’s how it would look:
($10,000 x 40%) / (1 – 40%) = $6,667
So, you would borrow $6,667 to add to the original $10,000 RRSP contribution. This would result in a tax refund equal to the amount borrowed above. The refund is then used to pay off the loan.
As mentioned above, this is a complex strategy that requires an in-depth understanding of tax rates, loan rates, and contribution room.
Summary
Please note, in order to make RRSP contributions you must have contribution room, which is accumulated based on earned income and carries forward annually if not used. If you are a member of a pension plan, please be aware of pension adjustments impacting your RRSP room. Lastly, please be aware of the risks associated with taking out loans to invest in a RRSP.
For more information on these concepts, please contact Jeff Graham at (604) 363-7549 or jeff@firstoakfinancial.ca.
DISCLAIMER: this commentary is provided for general informational purposes only and does not constitute financial, insurance, investment, tax, legal or accounting advice.