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

Posted on 2013 11 07 by BetCrooks

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.

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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.

What’s the Right Way to Invest? TFSA first? RRSP first? Pay down the Mortgage? Non-Registered Account? Gold? Real Estate? Help!

Posted on 2013 11 06 by BetCrooks

It fascinates me, like watching an unwary insect zig-zagging towards a waiting trap-door spider, to hear people asking what is the correct way to invest. Listening to and reading the answers to their frantic questions makes me even more uncomfortable. I don’t believe there is any one, correct way to invest. There are just too many variables. I think most people would be much better off in they could just relax a bit. There are many paths up the mountain and the view from 9,789 feet up is pretty close to that from 9,804.

Should I Max Out my TFSA First?

This is a common question. The answer though is a moving target.
TFSAs were only created 5 years ago. So the first year they were offered, you could max your TFSA with a $5000 contribution. When the “max” was that small, the consensus answer was yes, max out your TFSA first.

Even in 2014, the maximum someone who is 23 or older that year can contribute to a TFSA is $31,000 and that assumes they have contributed nothing ever (or have withdrawn everything from every TFSA they have in 2013).

$31,000 is still an achievable number, so it may be a good idea to max out a TFSA first.
But soon, that number will climb up to $50,000 or higher. At what point do you start to contribute to an RRSP as well as a TFSA?

Instead of a simple answer, it becomes necessary to consider a variety of factors:

What is your salary?
What is the expected change in your salary over the next 10-15 years?
Are you an impulsive spender?
Do you intend to buy a home (house or condo, etc.) soon?
Do you have debt? What kinds?
Are you planning to marry soon?
Do you have dependents (children, aged parents, disabled spouse, etc.)?
What income tax do you pay?

I’ll have to discuss some of these factors in a separate article. This one’s about the many paths up to that peak.

Should I Max Out my RRSP First?

This is probably the second most common question. It becomes the first during “RRSP Season” from January to February each year.

Many answers were written before the TFSA was invented and those answers have not been updated to account for this new investment possibility. Be wary and check the date of the information, especially in books.

One of the most common errors I see is people saying “Wait to contribute to your RRSP until you’re in a high tax bracket.”

They don’t seem to understand that contributing to your RRSP (and reporting your contributions on your annual tax return) and claiming the deduction for your contribution are two different things.

I could contribute to my RRSP in June 2013. I would have to report the contribution, with receipts, on my income tax forms for 2013. But I could wait till 2025 to claim the deduction to reduce my taxable income and to reduce my payable taxes (and maybe get a tax refund!). I just have to fill out Schedule 7. I could even wait till 2035!

One of the most common errors of omission I see is people not saying “If you are in a low tax bracket and you will probably be in a low tax bracket all your life, it’s better to save in your TFSA because it doesn’t affect your OAS and GIS eligibility and payments.”

That’s right: the real kicker is for very low income earners. If someone is going to have income of less than $15,000 (in 2013 dollars) in retirement from their pension, CPP, interest income on their investments, etc, they do not want to have a RRSP. Money coming out of the RRSP will reduce how much OAS or GIS they are entitled to receive. Money coming out of a TFSA will not reduce those payments. (At least it won’t as the rules are written right now. My cynical side expects that to change in the next 20 years.)

I need to explain these things in more detail in a separate article as well. But again, what I’m trying to say here is that there is no one simple, correct answer for everyone. Each person is unique and the best path for each person will vary.

Should I Pay Down My Mortgage First?

Again, this one used to be a no-brainer. People bought a house with a 50%+ down payment. They had a 25-year mortgage and they had 30 years till retirement. The interest rate on the mortgage was 7%+ and the interest rate on their GICs was 5%. There were no TFSAs. Their Pension Adjustments (PA’s) were so large because they had defined benefit pensions that they could only contribute $2,000 or less a year to a RRSP. They swore to everyone that they only planned to leave their home “when they were carried out in a box.”

In their cases, yes, paying down the mortgage made complete sense.

Now people are buying homes with tiny down payments. Some homes cost 5-10 times their owners’ annual gross salaries. They are buying them with a 25-year mortgage and 10 years till retirement. The interest rates, though, are low. They plan to down-size, right-size, convert to a rental property, flip or sell them to developers looking to drop a huge in-fill house on the super-sized lot.

It’s no longer a simple: “Yes. Pay off the mortgage first.” answer.

Real Estate? Gold? Non-Registered Accounts? RESPs?

The internet and the “celebrity-style” investment reporting on most news networks has just increased the confusion. The media is always buzzing about making millions in real estate, protecting yourself from world-wide-economic-collapse buy loading up on gold, avoiding the convoluted tax implications of registered accounts by keeping simple and investing only in non-registered accounts, and even using your kids’ RESPs as tax shelters for personal spending funds for their parents.

Argh!

So many choices, so much noise, so many ways to go wrong, lose money, not keep up with your peers, never get to retire, never get to travel, never succeed.

Enough.

I’ll repeat myself:

There isn’t any one correct way to invest. Many paths will lead to the same destination.
You don’t have to “get it right.” There is no wrong.
You don’t have to agonize and get paralyzed by all of the choices.
You will not be judged and found wanting.

Pick a path. Practically any path. Almost every one will lead you gradually up the mountain slope.

Don’t worry so much. The paths all criss-cross multiple times on the journey up. You can switch paths. You can even send some of your investments up one path while the rest of them follow another.

There are only a couple of choices that you must make:

Save money.
Don’t stay in debt.
Invest that money you save at a rate that exceeds inflation so it at least keeps today’s value.

Don’t worry about making the most possible profit from your money. No one knows how to do that successfully every time. Just try to make some profit and stop expecting perfection from yourself and your investments.

And try to tune out the endless stream of information that tells you “You’re doing it all wrong! Do it my way!” If you’re saving money, you’re doing it right.