RRSPs 102: Beyond the Basics - Part 2

Although the 2015 RRSP deadline is now but a fading memory, getting the most out of your RRSPs often involves thinking several years ahead, rather than just doing what you can when the end of February comes nigh. Accordingly, even though the flowers are blooming and the sounds of baseball season are in the air, I present to you the second part of my series on RRSP planning. This article continues to explore methods of wringing every last after-tax dollar out your existing and future RRSP contributions in the hope that your most pressing February concerns during retirement will be about things like what tropical vacation paradise do I want to explore next or is the year that the Leafs actually do make the playoffs.

I suspect many of you reading these words already have a firm grasp of the fundamentals. In fact, in my mind’s eye, I may even have seen a couple of you nod off or zoom ahead a few times while reading my first article (although I hope you didn’t skip the funny bits). For those of you who haven’t read the first article, however, and who don’t regularly talk about marginal tax rates while on the social circuit, I would suggest checking out my last piece in order to set the scene for the information below. As an added bonus, I did include a couple of advanced RRSP techniques that in the right hands can result in dangerous levels of tax savings.

Today’s piece continues looking at some of the advanced RRSP planning techniques designed to milk every last drop of tax savings from your RRSPs. In some ways, RRSP planning is like clothes shopping: one size does not fit all. Accordingly, I don’t expect all the options below to suit every financial situation. Also like shopping, however, sometimes all the hassle and energy of hunting through truly egregious ties or blouses better suited to wipe up cat sick is more than justified when you find the perfect garment (at a deep discount, of course). Likewise, even if only one of the techniques below fits your financial shape and contours, the results can still be magical. Let’s get the journey started…

Using RRSPs To Level Out

Unpredictable Incomes

Although the second “R” in RRSPs suggests that they are designed for retirement savings — and yes, that is their most common use — it isn’t as if this is etched in stone; sometimes you can reap huge tax savings in years when your retirement is still but a pinprick on a distant horizon. Does your income vary wildly from year to year, do you strongly suspect you will never use up all your RRSP room, or are you simply not an RRSP believer? If so, sit up straight, down a bit more coffee, and read on.

The basic idea is as follows. During high-income years, sock away extra money in your RRSP above and beyond what you’re earmarking for retirement. During lean financial years or when you finally take that year off to write your memoirs or travel the world in outrigger, pull out those extra dollars and pay tax on them while in a lower tax bracket. For example, if you’re in the highest tax bracket in B.C., you’d put away as much as you could in order to get a 47.7% tax refund now. If things are leaner the next year, it might be possible to pull out a bunch of money at a substantially lower rate. For example, any income up to just over $90,500 would be taxed at no more than 32.79%. Thus, every $10,000 contributed in the first year and withdrawn the next (such that total taxable income was $90,000) would generate more than $1,500 in savings, as some of this $10,000 would be taxed at rates lower than 32.79%.

Of course, when considering this strategy, it’s important to remember that it will mean less room to contribute to RRSPs later. As a result, you may want to ensure that you’re still keeping some of your RRSP funds intact for those days when you’re done working for good.

Pre-Retirement Dump-In

Are you approaching retirement, have lots of unused RRSP room and expect to be at a lower tax bracket when you retire? Even if funds are tight, consider dumping in a bunch of money during your last good-income year, even if you plan on pulling it out as soon as humanly possible thereafter. Even if you’re not in the higher tax brackets, the savings can be significant. Funds tight? Consider an RRSP loan. Although the interest on such loans is not tax-deductible, the tax savings from withdrawing the money at lower tax brackets can easily pay the carrying charges.

For example, assume you live in Vancouver and borrowed $10,000 in December of your final work year to bump up your regular RRSP contributions, reducing your taxable income from $87,000 to $77,000 and resulting in a tax refund of $3,100. If you pulled it out the next year so that your taxable income increased to $40,000, you’d have to pay tax of $2,006 on it. Assuming you had to borrow the money for three months at 4% interest, you’d be out $100. When the dust settled — assuming you didn’t earn a penny on your money — you’d still be up $1,000, and your only downside would be that you’d burned $10,000 in RRSP room (that you were never going to use anyway). Not a fan of borrowing money? Another option is to withdraw money from your TFSA in order to make this final RRSP contribution before the end of the year. Since you are always allowed to replace your TFSA withdrawals the next calendar and onward, you’d be able to use the tax refund from your original contribution, along with whatever is left after tax when withdrawing the $10,000 the next year (after having some of this withheld for that year’s taxes).

RRSP Homebuyerís Plan

For those of us living on the west coast, coming up with a down payment for that first home can be a daunting task. Furthermore, many of us want to come up with at least 20% of that amount so that we’re not stuck paying CMHC mortgage insurance. Fortunately, our friends in Ottawa want to help the cause, which is where the homebuyer’s plan comes into the equation. Everyone who hasn’t owned a home in more or less the last five years (or slightly less in some cases) can borrow $25,000 from their own RRSP to put toward a home. You need to pay yourself back eventually (at least 1/15 of the original amount must be paid back each year starting about two years after your purchase) or that amount is added to your taxable income that year. Since you already received a tax refund on the RRSP money when you contributed prior to your purchase, you don’t get another when you repay yourself in the future. Accordingly, if you have to choose between making fresh contributions and repaying the homeowners’ grant loan, repay the minimum only so that more of your money can be allocated toward new contributions that generate additional tax savings.

If you’re part of a couple and one of you isn’t working or there is a large disparity between your incomes, consider having the higher-income spouse make spousal RRSP contributions (assuming he or she already has or will still be able to contribute enough to come up with his or her own $25,000) so that the lower-income spouse will have a separate $25,000 to contribute to the cause. Obviously, this might take a few years of planning. If you are interested in this option, I suggest looking into the details before proceeding, as I have simplified things slightly in the name of readers’ mental health (and my own).

Post-Retirement RRSP Contributions And Spousal RRSP Planning

When you retire, your unused RRSP doesn’t retire with you. As a result, you are theoretically allowed to continue making contributions to your own RRSP until the end of the year in which you turn 71, provided you have the contribution room. Even better, for those of you with younger spouses, you are allowed to continue making spousal RRSP contributions until the end of the year in which your spouse reaches that milestone. For many of us, the prospect of making further RRSP contributions during retirement makes as much sense as wearing stripes with plaid — this is the time when we are generally withdrawing money from our registered plans rather than squirrelling away more for a rainy day. As well, the knowledge that whatever is left in your RRSP or RRIF at the last spouse’s death will be added to your taxable income that year is enough to give pause to many of us when stroking a cheque for yet another RRSP contribution. In many cases, these are compelling reasons to put your cheque-book back into your pocket. However, that is not always the case, and below are a couple of exceptions.

First, consider using up RRSP room when liquidating taxable assets that would push you into a stratospherically high tax bracket for that year — such as when selling a cabin or rental property, shares in a private company, or that stock market darling that will always have a warm place in your heart. Even if you pull out the extra money over the next few tax years, you could be well ahead in the tax game by spreading out the tax hit. When looking into this, however, you may also need to take into account things such as how your OAS pension might be affected down the road when you receive larger RRIF payments. Consequently, this strategy often works best if you are still a few years away from collecting and can pull out the money from your RRSP before triggering your OAS, or if you can put the money into an RRSP for a spouse with a much more recent birth certificate than your own. As well, keep in mind that it is now possible to defer the start of your OAS pension up to five years past the regular start date in exchange for higher payments later. Consequently, for some of us, it might make sense to take our friends in Ottawa up on this offer and whittle down the size of these registered plans during this period in exchange for higher OAS payments later (while also eliminating or at least reducing the amount of clawback coming your way when the government cheques do start arriving).

Second, if your income in early retirement is more than you expect in your later years — such as if you are working part-time or if you are a Sun Life advisor receiving personally-paid commission cheques (known to those in Sunlandia as “Core Payments”) for the first ten years after selling your block of business — it might make sense to continue growing your retirement war chest in some situations. This strategy becomes even more appealing if the tax deduction you receive allows you to get back some of your OAS pension (or at least reduce the clawback). Of course, deferring your OAS pension, and perhaps your CPP as well, during the early days might also make sense unless you’re not particularly bullish on the state of your health.

Third, spousal RRSP contributions during retirement can be a great way of deferring your day of reckoning, getting back some of your OAS Pension, and income-splitting down the line if there is a significant age difference between spouses. Since spousal contributions can continue until the end of the year in which the receiving spouse turns 71, it is possible that someone in his 90s can still put money into a spousal plan provided he has the room and his better half’s 72nd birthday is still at least a year away. For instance, the older spouse might use the minimum required RRIF payments he receives each year to fund an identically sized spousal RRSP contribution. Not only would the contribution offset the tax hit from the RRIF payment, the money in the spousal RRSP can continue to compound until the younger spouse triggers her RRIF. Even better, at that point, 100% of the income can be taxed in her hands (although up to 50% can still be allocated back to the spouse who originally funded the account if this produces a better tax result).

Conclusion

I’ve said it before (although perhaps not so poetically) and I will say it again: RRSPs are an incredibly valuable tool that can be the hammer and nails used for building the retirement dreams of many Canadians. But, like many tools, how it’s used has a huge impact on results: a chisel in the right hands produced the David, while in other hands the outcome might rival the efforts of a hard-working but not particularly talented fourth grader. I’m hoping this drives home my point about RRSPs. Sound investment decisions are essential (a little luck helps too), but this is not the only implement in your toolbox for success. Knowing how to manage your tax bill and taking advantage of some creative funding or withdrawal strategies to squeeze out extra savings can spell the difference between being able to vacation in Tahiti or Toledo during your golden years. In short, my hope is that some of the ideas in the last two articles will put you squarely on the path to mai tai’s on the lanais.

Colin S. Ritchie, LL.B., CFP, CLU and FMA is a Vancouver-based fee-for-service lawyer and financial planner who does not sell investment or insurance, just advice. To find out more, visit his website at www.colinsritchie.com.