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Should I Maximize my RRSP Contribution?

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June 27, 2011 , ,

Maximizing your RRSP savings is not always a good idea

How do you know if maximizing your RRSP contributions this year is a good idea?

The mutual fund industry will always tell you to maximize, maximize and maximize, despite your personal circumstances. What they fail to mention is that this can lead to massive tax bills on your estate, when almost half of your RRSP/RRIF funds can go to the government in taxes (as the government taxes it as “income earned in one year”)!

The key to avoiding this tax situation lies in how you contribute to your RRSP on a yearly basis. The general idea here is that you should maximize your RRSP in the years when you can save taxation this way. In the years when you have a low tax bill, you should avoid putting anything in your RRSP. This way, you can get the best combination of lower taxes both now and in the future.

For any particular year, these are the three key questions to ask yourself:

1. What is the tax refund I will receive on each dollar of RRSP contribution?
If you are in a higher income year, you will be receiving a higher tax refund (i.e. for $127,000 of taxable income, the refund is 46 cents per dollar). Here, you will want to maximize your RRSP contributions to enjoy less present taxes and allow your money to grow tax-free until retirement.

2. What will my tax bill be when I take money out of my RRSP/RRIF?
If you are in a lower income year, then your present tax bill will be fairly low. If you are maximizing your RRSP contributions every year in this situation, then you are simply creating a higher tax bracket for yourself in the future. Consider what your future tax bracket will be in your RRSP/RRIF years, and if this is higher than the present tax bracket, then do not contribute to your RRSP.

3. How much time will the RRSP be able to grow tax-free?
Generally, the younger you are (with a decent income), the more you can benefit from long-term tax free growth so RRSP contributions are encouraged. However, if you are earning less than $40,000 (similar to question 2), consider an alternative like the TFSA.

Remember that RRSP contributions depend on your personal situation and can change from year to year. Speaking to a trusted financial advisor can help you make the most of these tax minimization strategies.
One quick and free tool can be found on our website. The Tridelta Retirement 100 helps you see your likelihood of running out of money, your likely estate size and lifetime tax bill. By playing with RSP numbers, you can see the impact yourself.

The RSP: Minimize Your Biggest Future Tax Bill

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May 12, 2011 , , , ,

In the future, your biggest tax bill will be your RSP taxes.

We all know of the benefits of tax refunds and tax-free growth for RSP, but what happens after you retire?

Here is how the RSP taxation works:

• Your RSP grows tax-sheltered until you draw out money. Any money you withdraw each year is considered “yearly taxable income” for tax purposes.

•If you wait to withdraw your money, the year you turn 72, your RSP turns into an RIF, which means that the government mandates you must withdraw at least 7.48% each year and pay tax on it. If you are married and you pass away, the RSP/RIF will simply transfer over to your spouse.

• The year the surviving spouse passes away, the entire value of the RSP/RIF is considered one year’s taxable income. If you have a $500,000 RIF left at that point, the government will take $212,000 in taxes!! This is often shocking to the estate.

A few tips to help you avoid your biggest future tax bill

How do you avoid this huge tax hit?

1. Don’t save so much in your RSP in the first place. Unless you are in the top tax bracket (and enjoying the maximum RSP refunds), saving too much now can lead to a massive tax hit at the end. In low income years, put less or nothing into your RSP.

2. Draw more money out while you are alive to enjoy it. From a pure financial perspective, you want to draw out registered money in years when it can be done at a lower tax rate – those years when you have very little other income. From a philosophical point of view, you want to draw out the funds when you are still able to enjoy it.

3. You can use strategies like the RSP meltdown to effectively draw out more money from your RSP by creating a tax deduction equal to the amount withdrawn. This strategy can be quite effective for many people, but does require some leveraged investing, and you might require professional advice.

The main message here is that you need to have a long-term tax minimization strategy, instead of simply saving up RSP funds.

One quick and free tool is the The Tridelta Retirement 100, which helps you see your likelihood of running out of money, your likely estate size and lifetime tax bill. By playing with RSP numbers, you can see the impact yourself.

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