Your RRSP is more than just a retirement plan..
The 2022 RRSP contribution deadline is March 1st, and this time of year always brings up a thousand questions - Should I contribute? What are the tax implications? Are there benefits beyond retirement funds? Are there better options?
We’re breaking all that down today and looking at a few lesser-known hacks that can super-charge your wealth using this tried and true savings plan.
The 411 on RRSPs
An RRSP (Registered Retirement Savings Plan) is a tried and true, low-risk savings plan that has been around since the late 50s as a way for Canadians to tax-shelter their wealth while they grow it for retirement. The funds you contribute over your lifetime can sit still as with any old savings account, or you have the option of investing them to increase their value faster. Contributions are deducted from your taxable income, and every Canadian may contribute up to a maximum limit (set by the Canada Revenue Agency) that changes year. When retirement rolls around, funds may be withdrawn to continue to support your lifestyle, but withdrawals are taxed as income as this time.
As we have discussed around here a ton, the federal First Time Buyers’ plan allows Canadians to withdraw up to $35,000 per person from their RRSP, tax-free, to contribute to their down payment. The catch? Funds must be repaid within 15 years, or taxes will be charged. Simply put - the RRSP is a vehicle that most Canadians leverage in one way or another over our lifetimes. If not for our first home down payment then for our longer term financial goals. But there are so many ways that this little tool can help you even more than that!
Tax implications
Since any contributions you make to your RRSP each year are deducted from your taxable income, many Canadians opt to invest yearly to reduce their tax bill or increase their tax refund.
But it’s important to remember that in Canada, we are taxed on what is referred to as a marginal tax system. Essentially this means that the more money we make, the more we are taxed and vice versa. You’ve likely heard the term tax bracket before, which refers to the range your income falls within that determines the level you are taxed at. Your marginal tax rate, on the other hand, is the rate of tax you pay for every dollar earned - it is also your rate of tax savings when you make a contribution to your RRSP.
This rate is based on 2 factors - your gross earnings, and the province you live in. Calculating your own marginal tax rate can be complicated, but you can find a great breakdown of what your combined federal and provincial rate is here. Now, let’s take a look at a quick example.
If you earn $120,000 per year in Ontario, your marginal tax rate will be 33.89% on regular income and investment interest - which means that you will be liable for $0.3389 on every additional dollar earned. And remember, the rate of taxation is the same as the rate of savings on RRSP contributions. Therefore, if you have $10,000 to contribute to your RRSP this season, this would reduce your tax liability by $3389. To do a quick calculation of what your tax savings would be, take a look at the charts linked above. You’ll also want to consider whether you have any space leftover from not maxing out your contributions from previous years, and that you can actually defer the credits afforded by your contribution to a future year - a year, for example, when income has been less steady and you’ll want to decrease your tax bill by even more.
Remember though, that your best bet is to connect with a tax accountant before making a lump sum contribution!
RRSP vs mortgage prepayment
While you’re in the process of considering a lump sum RRSP contribution, you’ll also want to connect with a mortgage professional. Why? Because if you have a fixed sum of cash sitting around, you may find that a lump sum prepayment to your mortgage principal is actually more beneficial to your bottom line than a contribution this year.
As a general rule, you can assume that if your mortgage interest rate is equal to or higher than the rate of return on your RRSP, you would be better off allocating that cash to a lump sum mortgage payment. For example, if your current mortgage rate is 5%, and you know that your current RRSP investment plan yields about 3%, then you might consider a mortgage payment first. However, you’ll also want to consider the overall cost of paying down your mortgage debt versus the tax savings afforded by a contribution. For example, if your $10,000 contribution would reduce your taxable income by about $3400 as above, how would that stack up to your overall interest savings putting the same amount toward your mortgage?
I know - it sounds complicated (and it kind of is) - which is why I recommend reaching out to a member of our team to crunch these numbers together!
Hacking your RRSP to buy your first home
Of course in our line of work, we consider the RRSP one of the best tools for helping you purchase your first home. As I mentioned above, the Home Buyer’s Plan (HBP) allows every Canadian to withdraw up to $35,000 from their RRSP untaxed to contribute to their first down payment. But did you know that there are a few ways to hack your RRSP to further increase the benefit of this program?
First, let’s say you are well on your way to having your down payment saved up and are planning to buy in the next year or so. Having the cash in the bank is great! But by routing it through your RRSP, you could actually add thousands of dollars to that pot! It’s simple - make a contribution for as much as your current limit will allow. If you haven’t maxed out your contribution in previous year then you could potentially contribute the entire $35,000 that you will be allowed with withdraw under the HBP. If you have a salary of around $100,000, this contribution could increase your tax refund this year by over $10,000! Then, after a minimum of 90 days, you will be able to withdraw that same $35,000 tax-free to make your down payment, but you will have an extra cash influx on hand!
Or perhaps you are focused on saving your down payment but the cash isn’t coming quite as quickly as you’d like. If you are qualified to do so, you can actually access a loan to contribute that $35,000 to your RRSP. Then, after a minimum of 90 days, you can withdraw it to use toward your down payment! Of course, it’s important to remember that the loan you’ve taken out will be included when calculating your debt ratios for your mortgage qualification. With that in mind, it’s important that you connect with a mortgage professional to look at your entire financial situation before jumping in to this particular hack.
The bottom line
Once upon a time, the RRSP was thought of as a bit of an outdated retirement planning tool. However in our line of work, and with the market as uncertain as it is, the trusty Registered Retirement Savings Plan is having something of a renaissance as a wealth building tool for both short and long term financial goals.
If you have questions about how to best allocate your cash this RRSP season, heading into tax time or are just considering what home ownership could look like for you this year, schedule a call with our team to discuss all of your options!
