How to maximize the value of your RRSP

It’s the start of 2017 and a brand new year. However, for RRSP purposes, it’s still 2016 until the end of the day on March 1, as that is the deadline to make your RRSP contributions for 2016. Contributing TaxLetter editor Samantha Prasad LL.B. offers five tips to maximize the value of your RRSP contribution.

If you are still unsure as to what you should be doing when it comes to making the most of your RRSP, below are five key tips for managing and contributing to your RRSP.

• Tip #1—Take full advantage of spousal RRSPs

A spousal RRSP is simply an RRSP where you make contributions, but the plan is in your spouse’s name—i.e., owned by him or her. It’s a relatively straightforward way to split income. When you contribute to an RRSP in your spouse’s name, you receive a personal tax deduction. But since the RRSP belongs to your spouse, amounts received from the plan generally will be taxable to your spouse, not you.

The object of a spousal RRSP is to allocate taxable income as evenly as possible between you and your spouse, so that you will both be in a fairly modest tax bracket. So if your spouse will be in a lower tax bracket than you when the RRSP is paid out, a spousal RRSP makes sense because withdrawals eventually will be taxed in his or her hands.

Another advantage is that the maturity deadline of a spousal RRSP is based on the age of your spouse. If you’re too old to contribute to your own RRSP, it may be possible to continue to contribute to a younger spouse’s RRSP. Of course, you must have what’s known as ‘earned income’ to do this (which includes employment or business income, alimony received, and rental income, among other income sources, but does not include items such as investment income). A spousal plan may also be a good idea if the contributor spouse is concerned with potential creditor problems.

There are rules relating to ‘quick withdrawals’. Amounts withdrawn from a spousal RRSP must be included in the income of the contributor spouse to the extent of tax deductible contributions either in the year of withdrawal or in the previous two years. This includes ‘lump-sum’ RRSP withdrawals made after the plan has matured.

Note—to the extent that you are pension splitting (i.e. where up to half of eligible pension income (including RRSPs) is allocated to a lower-income spouse or partner), the spousal RRSP may not give you any additional benefit.

• Tip #2—Make ‘catch-up’ contributions

If you haven’t ‘maxed out’ on your RRSP contributions in the past (going back to 1991), you’re entitled to make an additional contribution over and above your normal limit for the year. That’s because, (effective as from 1991 onward), your ‘unused’ RRSP contribution limit can be carried forward indefinitely to future years. Of course, one of the biggest barriers between you and your write-off could be finding the means to make a catch-up contribution. Possible sources for your catch-up contribution could include inheritances, contributions in kind, an RRSP mortgage or borrowing.

Note: If you make a very large RRSP contribution, you could be subject to the so-called ‘Alternative Minimum Tax’. But even if this is the case, the extra tax you pay can be applied to reduce your future regular taxes. In the meantime, your RRSP nest egg will be earning income on a tax-sheltered basis.

Another thing to bear in mind is that the higher your tax bracket, the more effective your RRSP contribution will be. So a low-income year may not be a good time to make a catch-up contribution. If your annual income is such that you’re not ‘too far into’ a particular tax bracket, you may want to make a series of RRSP contributions which take you down to the ‘bottom of the bracket’. Another alternative could be to make a lump-sum contribution but defer the actual deduction until a year when you’re in a higher bracket.

• Tip #3—Put the high-tax stuff in your RRSP

It has been said that you should hold high-tax investments in your RRSP and low-tax investments outside your plan. But which investments are high-tax? Traditionally, these have been interest-bearing investments. Stocks and equity funds, on the other hand, may qualify for capital gains treatment (50 per cent of a capital gain is tax-free), as well as the dividend tax credit if Canadian. These benefits are lost if you hold through your RRSP, since retirement and other amounts you receive from your plan are fully taxable. So if you have investment capital both inside and outside your RRSP and you wish to invest in both equities and fixed-income investments, it is generally better to hold the former outside your RRSP and the latter inside your plan.

Can equities be high-tax investments? A case in point arises if you’re contemplating a big, short-term capital gain. In this case, the equity investment could, in effect, become high-tax, since you have to pay this tax for the year you sell, while the gain can be tax-deferred in your RRSP. Owning short-term-hold equities in your RRSP could defer capital gains tax for years—giving you the opportunity to take profits and reinvest on a tax-deferred basis. In some cases, this may more than make up for the tax breaks you get by holding outside your RRSP.

It may make sense to hold part of a high-appreciation equity position—the portion you may liquidate—in your RRSP. (Careful though: transferring existing investments into your RRSP triggers capital gains tax, if they’ve appreciated in value.)

If an equity is a long-term hold, the “outside-the-RRSP” strategy still applies.

Finally, it makes little sense to select your investment portfolio just to get the tax benefits. For example, if you like an equity investment, then by all means invest through your RRSP if that’s where your capital is.

• Tip #4—Building in contribution room for your family

If you carry on a business, it may be that you are paying your children a salary. If so, this not only creates contribution room for your kids but also results in a deduction for your company. (Note—make sure the salary is not unreasonably large in light of the services they are actually providing the business.) Every person (including children) can receive up to $11,635 for the 2017 year without paying tax by claiming the federal basic personal tax credit. Moreover, the salary your child receives should qualify as ‘earned income’, so that he or she will be entitled to make an RRSP contribution based on 18 per cent of the salary. This can be carried forward over the years.

For example, if you had two children and paid each child $11,000 a year for ten years, and this was their only income, no tax would be paid. However, each child would then be eligible for a tax write-off of $19,800 over the ten years because of the RRSP carry forwards (remember they contribute 18 per cent of their annual earned income each year), which could be used to reduce their taxes when they have higher income. So your two kids, together over the ten years, could be in a position to claim write-offs of $39,600—and your business would have enjoyed lucrative write-offs in the meantime.

• Tip #5—Don’t wait to contribute

Okay, this tip is pretty obvious, especially if you haven’t yet contributed. But you’d be surprised at how many people wait until the end of business day on the last day to contribute. Even if you happen to have already made your contributions for the year, this tip is still worthwhile since there’s no time like the present to start contributing to your 2017 RRSP. If you have the cash available now, don’t wait until February 2018 to contribute to your 2017 RRSP. Why pay tax on your interest income while it sits in your bank account when your income could be tax-sheltered in your RRSP?

Samantha Prasad, LL.B., is a tax partner with the Toronto-based law firm Minden Gross LLP, a member of Meritas Law Firms Worldwide, and a contributing editor of The TaxLetter. She can be reached at sprasad@mindengross.com. 

 

This is an edited version of an article that was originally published for subscribers in the January, 2017, issue of The Taxletter. You can profit from the award-winning advice subscribers receive regularly in The Taxletter.

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