While they are called “Registered Retirement Savings Plans,” there is no law that states you have to use these accounts strictly for the purpose of retirement funding. In fact, those who are self-employed or with cyclical income may find that it serves as a great income-smoothing tool with tax savings to boot.
First, let's make sure we understand the basics of an RRSP, which is, essentially, a tax-deferral tool.
Making an RRSP contribution, and claiming the subsequent deduction, allows you to reduce your taxes owing. Assuming you've paid your taxes along the way, you'll get a refund after your filing is processed. Anything happening inside the RRSP is tax sheltered, but once you take funds outside your RRSP (known as a deregistration of funds), it's almost like receiving salary income as it will be taxed at your marginal tax rate. So, really, it allows you to time when you are taxed on a portion of your income.
This can really make sense if you make contributions in years with high marginal tax brackets (i.e. when you are working) and making deregistrations in years with lower marginal tax brackets (i.e. retirement).
However, if we think outside the box a bit, there are some other situations where one can cycle between high and low marginal tax brackets. Perhaps you are in sales or you are a consultant and your income is very cyclical. There are years where you shoot the lights out and others where you might have made more money working part-time at the local video store. Whatever the case may be, there is potential to save some tax.
Option 1: Make your contributions, but defer claiming the deductions
When you make an RRSP contribution, almost everyone claims the corresponding deduction in that tax year, but you don't have to. You can carry forward the deduction indefinitely. That means you can put $5,000 in for the 2010 tax year, but claim the $5,000 deduction in a future year. That way the money is in and hopefully growing, but you can maximize your tax savings by claiming the deduction in a higher-income year.
Option 2: Contribute and withdraw in perpetuity
If your income is volatile, you can contribute and claim the deduction in high-income years, and deregister funds when your income falls into a lower tax bracket. You get big tax savings in the contribution years, but can pay less in tax on the withdrawal years. The greater the disparity between tax brackets, the better. Keep in mind, however, that using all or part of your RRSP in this manner burns up contribution room, so you have to weigh the foregone growth, if you had let the funds compound, and the reduced chance to make future contributions specifically for retirement funding.
Preet Banerjee is a senior vice-president with Pro-Financial Asset Management. His website is wheredoesallmymoneygo.com