Registered retirement savings plan season isn’t what it used to be. That’s partly because competition from tax-free savings accounts has muted the annual RRSP contribution rush. It’s also because people have gotten smarter and are contributing to their RRSPs all year round instead of joining the last-minute dash before the March 1 deadline.
But RRSPs are still a hot topic, judging from the reader queries we get at Investor Clinic.
We’ve been saving up your questions, and today – in the first of two instalments – we’re pleased to bring in an expert to answer them. Jamie Golombek is managing director, tax and estate planning, with CIBC Private Wealth Management. Investor Clinic thanks him for his “contribution” and wishes him a very large tax refund.
I’ve been wondering about the “year off” scenario with respect to RRSPs. I make about $100,000 a year and have $30,000 in unused RRSP contribution room. In the next few years, my wife or I will take a year off to do an MBA, travel or have a child. I was thinking of putting money into a spousal RRSP and then taking it out three years later at a much lower tax bracket. Are there any potential “gotchas” I should know about? -D.R.
A spousal RRSP is an RRSP in which Spouse A, in this case you, contributes to Spouse (or partner) B’s RRSP (your wife’s). The amount you can contribute is based on your available RRSP contribution room and you claim the corresponding tax deduction on your return. The funds, however, now belong to your wife and are generally taxed in her hands when withdrawn. If her tax bracket will be lower than yours when such a withdrawal takes place, then you’ve successfully accomplished spousal income splitting on the RRSP funds withdrawn.
There is, however, an anti-avoidance rule to prevent short-term income splitting of spousal RRSP contributions which states that if you contributed to any spousal RRSP any time in the current or prior two calendar years, spousal RRSP withdrawals up to the amount you contributed in that period will be taxed in your hands rather than in your wife’s name. So in your case, assuming that you do wait the three years, you should be fine.
Your idea makes sense if her tax bracket at the time of withdrawal will be less than yours when you make the spousal RRSP contribution. The only caveat is that you won’t get your RRSP contribution room back. In other words, unless you have a large amount of unused RRSP room carried forward that you don’t anticipate ever using, then your strategy is shortsighted in that you are permanently giving up tax-free investment growth in your RRSP over 50 years or more for a one-time, short-term tax savings.
I have a mortgage of roughly $200,000, with an interest rate (locked in for five years) of 3.89 per cent. When I bought my house, I withdrew $25,000 from my RRSP under the Home Buyers’ Plan (HBP), and I have to pay that money back over 15 years. My marginal tax rate is about 33 per cent. I have enough cash flow to max out my yearly RRSP contributions and pay more than the minimum for the HBP, but I am wondering if I should use the extra money to pay down my mortgage instead. -P.G.
The mortgage or the RRSP – it’s a classic question. Generally speaking, you would be best to put the funds toward the vehicle with the highest return. Do you think you can earn more than 3.89 per cent (guaranteed!) after-tax equivalent in your RRSP over the long term? Remember, when you pay down your loan, you will in effect be earning a guaranteed after-tax return of 3.89 per cent. If you think you can beat that, you should repay your HBP faster. If not, making additional payments toward your mortgage may be your preferred route.
3. Is there any penalty for overcontributing to an RRSP, or can overcontributed amounts eventually be claimed in subsequent years? I recently built up a position in a U.S. stock and would like to move it all into my RRSP right now to reap the full benefit of dividends. Only trouble is, this year's contribution room is already full, and my U.S. investment is greater than next year's contribution room will be. Since there are some excellent U.S. dividend stocks going for very low prices, I would really like to load up on them now and store them in my RRSP, but only if there’s no penalty for doing so! -R.W.
The penalty is 1 per cent per month of any overcontribution beyond a lifetime cumulative overcontribution allowance of $2,000. You’d be best not to exceed your RRSP limit as you’d have to exceed a 12-per-cent annual after-tax rate of return on those U.S. stocks just to beat the overcontribution penalty.