A question came up recently on RedFlagDeals from someone looking to the future and trying to improve their tax refund in 2016 for their 2015 taxes. The person said that when he and his wife did their tax returns for 2014, they received some of the Family Tax Cut, but not the maximum of $2 000 per family. His wife is working and has unused RRSP room but is in a low tax bracket and therefore they haven’t bothered to have her contribute much to her RRSP. He wanted to know, if his wife contributed to her RRSP in 2015, would it increase their Family Tax Cut to the maximum of $2 000; I wasn’t sure so I ran some test cases to see if he could get the maximum by having his lower income partner put more into her RRSP.
What Is the Family Tax Cut Based On?
If you look at Schedule 1-A you’ll see that the Family Tax Cut is calculated using your taxable income from line 260 of your return. Line 260 occurs after your income is adjusted for any RRSP contributions.
In this question, the person wants to know if the lower-income spouse should reduce their income even further by contributing to their personal RRSP to get the highest possible Family Tax Cut.
The arithmetic answer is Yes. By contributing to their personal RRSP, the person making the least money can increase the amount that can be used for the “paper” transfer from the higher income person to the lower, and therefore they can maximize their Family Tax Cut up to the limit of $2 000.
Can Everyone Benefit With a Higher Family Tax Cut By Contributing More to a RRSP?
No.
- Some families are already receiving the maximum $2 000 family tax cut. Changing RRSP contributions will not increase the amount.
- In some families the two incomes are very similar. Although a RRSP contribution might increase the Family Tax Cut, it may not increase it significantly. If this situation applies to you, you might want to test the benefit yourself using free tax software for 2014 from StudioTax or GenuTax Standard. Try adding the increased RRSP contribution to the lower income spouse’s return and then check Schedule 1-A to see what, if anything, changed with the Family Tax Cut.
- In some families, the lower income earner does not have any RRSP room. (For example, they might only have investment income.) Without personal RRSP room they cannot change the Family Tax Cut calculation.
NOTE: Contributions to a Spousal RRSP by the higher paid person for the benefit of the lower paid person do NOT increase the Family Tax Cut.
What Is the Possible Downside of Having the Lower Income Partner Contribute More to a RRSP?
It’s important to also look at this from a long-term tax perspective.
If the lower earning partner does not make much money, they will not get much of a tax refund for their RRSP contribution if they claim the deduction immediately. (And they must claim the deduction to get the higher Family Tax Cut.)
Then, when they eventually withdraw the money from the RRSP either in retirement or for an emergency, they will have to add the amount to their taxable income at that time.
This could mean they will pay tax at a higher rate on the RRSP money when they take it out than they received back as a refund and as a benefit from increasing the Family Tax Cut when they put it in.
For example, say someone has an income of $20 000 and contributes $5 000 to a RRSP in order to maximize the Family Tax Cut. In the test case I ran, that person received a tax refund of about $1 215 and increased their Family Tax Cut by $323.
Now suppose when she retires she is receiving
- $8 000 a year in CPP,
- $6 000 a year in OAS, and
- $40 000 a year from a pension and investments.
If she takes out $5 000 from her RRSP, she will owe $11 498 in tax if she lives in Ontario, based on the 2014 tax rates.
If she doesn’t withdraw the $5000 her income tax is only $9 940.
Her tax increase is $1 558.
She is paying $20 more in tax than she saved. That’s not a very large amount, fortunately.
She will also have to pay income tax, however, on any investment income and capital gains generated by that $5 000 while it was in her RRSP when she withdraws the money from her RRSP or RRIF.
The calculation of whether it’s a good idea can get very messy:
- What will the tax brackets and rates be when she withdraws the money from her RRSP/RRIF?
- How much has inflation increased between when she saves the money and when she has to pay the income tax on the withdrawal?
- Will the family invest the money saved using the Family Tax Cut and if so, what return will it generate to offset the future tax liability?
I can’t simply say that it’s a good idea or not to make a RRSP contribution to maximize the Family Tax Cut. It will depend on too many factors. You should consider some of the possibilities, though, before deciding how to best use your money.
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Have you tried to optimize your Family Tax Cut by tinkering with RRSP contributions? Are you one of the majority of Canadians who doesn’t benefit from this Cut so you don’t care? Please share your views with a comment.
