Optimize Your RRSP: Contribute Now, Claim the Tax-Reducing Deduction Later

During RRSP season, from January to March, huge ads shout that we should contribute to our RRSPs and enjoy getting a big tax refund when we file our taxes in April. That message tightly connects those two events and many people think that’s how you must use a RRSP. It’s isn’t. Depending on what income you are earning and when, you may find the best way to optimize your RRSP is to contribute now but claim the deduction later to reduce your taxes and get a refund.

In this article, I briefly describe how to report your RRSP contribution and deduction information on your tax forms. Please double check your tax return with a tax professional or the CRA if you have any doubts. I am not a tax professional. I’m just a tax payer.

Why Do Banks Make It Sound Like You Have To Claim Your RRSP Deduction Immediately?

Banks understand what motivates people. Saving money for retirement 40 years in the future doesn’t sound very interesting. “Why bother?” many people might ask.

So the bank trumpets “Get your Tax Refund by contributing to your RRSP today!” They use delicious examples:

“Contribute $5000 to your retirement! Get $2500 of your own money back from the taxes you paid the government!”

(That example assumes you earn $200,000 a year in Nova Scotia but they only put that in the tiny print.)

People love tax refunds. Many use it to splurge on something like a new TV or a trip. The bank ads get them in the door to make their RRSP contribution.

How Do RRSP Contributions Work?

On your tax forms, there are actually 2 parts to your RRSP contribution.

First, you must report any money you contributed to your RRSP each tax year. It’s the law. You will get fined if you don’t.

Second, you must decide how much of that contribution to claim as a deduction.

The amount you claim is used to reduce your income for that tax year. Because your income is lowered, the amount of tax you owe is also lowered. If you have pre-paid your taxes by deductions from your pay cheques (which most of us have had to do) then you probably will get a tax refund because now your income is lower than what was used to calculate how much tax to pre-pay the government.

Most people think you must claim a deduction for the entire amount you contributed to your RRSP. That’s wrong. You can claim all, some or none of it. Any amount you don’t claim as a deduction one year is carried forward to the next year.

You won’t get any tax refund until you claim the tax deduction for the RRSP contribution.

How Long Can I Wait to Claim the Tax Deduction for my RRSP Contribution?

I’ve actually done this. There were some years when I knew I would get more tax refunded if I waited and claimed the deduction a few years after I made my RRSP contribution.

I knew I could carry forward the right to make a deduction for several years. Today, I phoned the Canada Revenue Agency to check how many years I could carry it forward.

The answer was it can be carried forward indefinitely. You could make a contribution this year, and report that contribution properly on your tax return for this year, but wait 5, 10, even 20 years to claim the tax deduction for that contribution.

Why Would I Want to Contribute to my RRSP If I’m Not Getting a Tax Refund Immediately?!

The money you contribute to your RRSP can be invested to start earning more money. Those investment earnings grow tax-free inside the RRSP.

I contributed to my RRSP before I wanted to get the tax refund so my investment earnings could grow a few more years tax-free than they would have if I’d waited and contributed to my RRSP the same year I wanted to claim the tax-reducing deduction.

Why Might It Be Best to Delay Claiming the Tax-Reducing RRSP Deduction Until Later?

If your income is significantly lower this year than it will be in a future year, you may get a larger tax refund if you wait to claim your RRSP deduction.

Here’s a few quick examples. Perhaps this year:

• You are taking parental leave. Your income will be about 50% lower this year than next year.
• You are currently unemployed and have been most of this year. But you’ve just landed a great high-paying job to start in January, so next year you’ll be in a high tax bracket.
• You have lots of RRSP contribution room from working part-time as a student. You started your high-paying full-time job this September after graduating so you have money to invest in your RRSP, but your total income for this first part-year of work will be much lower than next year.
• Or, you’re the same student, but you have enough tuition and other credits to apply that you won’t get as big a tax refund if you claim your RRSP deduction this year as you would if you delay it another 2 years.
• Your base income this year and next will be very similar, but next year you know you are getting a huge cash bonus from RSUs that were granted years ago but don’t vest until next year. The bonus will move you way up into another tax bracket.

How Do I Know How Much I’ll Get Back? When Should I Claim the Deduction?

You can calculate an approximation of your RRSP tax refund for 2013 using a free online calculator from Ernst & Young LLP at http://www.ey.com/CA/en/Services/Tax/Tax-Calculators-2013-RRSP-Savings.

Try it for your current income level. Then play with it. What if you made $20,000 more a year? $40,000?

You probably have some idea what income you can expect in 5 years if everything goes well with your job.

Maybe it will only be 2% a year higher than what you are earning now. In that case, it’s unlikely to be worth delaying claiming the tax deduction. (Unless you are planning to withdraw the money under the Home Buyer’s Plan or Lifelong Learning Plan. I’ll explain this in another article.)

Maybe you expect to be earning 20% more than you are earning now. You may be a new hire in a field where the pay scale grows quickly as you get more experience, such as a doctor, lawyer or engineer. If so, it might be worth delaying claiming your tax refund.

Maybe you can expect to earn 50% more than you are earning now, because you are currently working part-time at a burger counter but you expect to land a professional job soon as you are upgrading your skills at night and continuing your post-grad job search.

Play with the numbers. If there isn’t going to be much difference between claiming the deduction now and later, go ahead and claim it now.

How Do I Report This On My Tax Forms?

To understand how to report delaying using your RRSP deduction on your tax forms, please see the article: “How to Report Your RRSP Contribution If You Don’t Want to Take the Tax Deduction Yet.”

Remember You MUST Claim Your RRSP Contribution the Year You Make It!

Please, please, please remember you MUST claim your RRSP contribution the year you make it when you file your tax return in April. You have to report it on Schedule 7 and attach your RRSP receipts to your return (if you are paper-filing; or keep them for 7 years if you are e-filing).

It is against the law not to report your RRSP contributions. You will face huge cash penalties if you put in money and don’t report it!

The government will know because your bank or financial institution will eventually file a report stating you have made your contribution. The government will decide you deliberately lied and cheated if you haven’t also reported the contribution and they will penalize you.

Disclaimer

Please remember I am not a tax specialist. I’m just a regular tax payer. Please talk to the CRA or a tax professional if you need any advice or help with this. I am not responsible for you reporting your taxes properly. This information is just intended to show you an option you may want to check out.

Related Reading

• How to Report Your RRSP Contribution If You Don’t Want to Take the Tax Deduction Yet
• RRSP Strategies Part 1: How To Best Get your RRSP Money Contributed Before the Tax Deadline

Join In
Have you ever deferred taking the deduction for your RRSP contribution? Did you wait one year or more? Was it the right decision? Please share your experiences with a comment.