Some sound advice to get the
most out of your RRSP!

 

With all the information going around about Registered Retirement Savings Plans (RRSPs) in the past few years, most of you are probably sold on the advantages of this retirement plan, which enables you to defer income tax and benefit from the magic of compound interest tax free. However, as the deadline for RRSP contributions for the 2001 fiscal year is next March 1, we would like to offer you some tax and financial advice which will enable you to get the most out of your savings.

1. Why give the government what you can give to your spouse?

There are simple and effective ways of saving income tax if you are a couple: Contribute to your spouse's RRSP and pay off your day-to-day expenses while saving income tax. In effect, an easy way of saving income tax is to place emphasis on the unregistered savings of the spouse with the lower income. The investment-generated income will therefore be taxed at a lower rate.

By contributing to your spouse's RRSP, you are not only receiving the immediate tax deduction resulting from the contribution, but you are splitting family income at retirement, which gives you the advantage of:

A couple can take advantage of numerous tax breaks by using this income splitting technique. The principle is straightforward. You can contribute to your own RRSP or to a spousal RRSP. The total contributions must not exceed the permitted limits. Moreover, this does not affect, in any way, the allowable limit of contributions your spouse can make to his/her RRSP.

It is important to note that if a contribution paid in your spouse's name is withdrawn during the two calendar years following the year of contribution, the person making the contribution (the contributor) will have to pay income tax on the withdrawal. After that time, the recipient (the spouse in whose name the RRSP is registered) will have to pay the tax. If you think you will be making a short-term withdrawal, contribute to your RRSP immediately prior to December 31 rather than before March 1 of the following year.

In conclusion, income splitting has to be planned well before you retire, and do not wait until retirement, as it is then too late. The earlier you follow the aforementioned techniques, the more they will pay off for you. However, before opting for these solutions, it is important that you evaluate the forecasted income of each spouse at retirement with your financial planner.

When contributing to an RRSP, time is money! So even though you can carry over your unused contributions for an indefinite period, you are better off making the maximum contribution to your RRSP as soon as possible to take advantage of the combined effect of compound tax-sheltered income. So if you do not have the money you need to make the maximum contribution, it would perhaps be a good idea to borrow.

In most cases, the long-term cost of the contribution you do not make, i.e., the forsaken compounded income which would otherwise have been generated, will exceed the cost of the loan, provided it is paid back quickly, generally in less than one year. So once you have borrowed to contribute to your RRSP, your goal should be to pay the loan back as quickly as possible. A simple way is to take your tax refund to pay it off, which will shorten the repayment period.

Once the loan has been paid back, we advise you to continue making the payment to an RRSP savings account, which will reduce the amount you will have to borrow the following year to make your contribution. It is useful to know that, unlike interest paid on a loan for investment purposes, interest payable on a loan used to contribute to an RRSP is not tax deductible.

Even though it is preferable to maximize your contributions to an RRSP, it may be that a loan is not the most cost-effective solution. We therefore advise you to consult with a financial planner so that you take the most advisable course of action.

The RRSP is truly a powerful financial management tool which will enable you not only to achieve financial autonomy at retirement but also to purchase your first property with the Home Buyers' Plan (HBP) or return to school full time with the Lifelong Learning Plan (LLP). Both plans allow you to take funds out of your RRSP without tax consequences, provided the rules governing these plans are followed. We encourage you to contact your financial planner for more information.

Written by: Renée Trépanier, CFP
Personal Financial Management Educator
SISIP Financial Services, Ottawa