Excerpted from 101 Tax Secrets for Canadians: Smart Strategies That Can Save You Thousands, copyright 2010 by Tim Cestnick.
Contribute to your RRSP instead of paying down your mortgage.
Canadians love real estate. Canadians also love to pay down the mortgage on that real estate as quickly as possible. I can understand why. On a $100,000 mortgage amortized over 25 years with an interest rate of 8 per cent, you’re on course to pay over $128,000 in interest alone over 25 years. Scary, isn’t it? But hold on a minute.
When you’ve got to make a decision between paying down the mortgage or contributing to an RRSP, many Canadians make the wrong move. Your best bet, in almost every case, is to contribute to your RRSP. If you took the time to do the math, you’d agree with me.
Only in very rare circumstances does it actually make sense to pay down the mortgage first. If the following two conditions are both met, then by all means pay down the mortgage as your first priority:
• the interest rate on your mortgage is 3 per cent higher than the expected rate of return in your RRSP, and
• you’re committed to contributing your annual mortgage payments to your RRSP once the mortgage is paid off.
Meeting the first of these conditions is going to be unlikely, so your best option will generally be contributing to your RRSP first. But why not have your cake and eat it too? Here’s how: Contribute to your RRSP each year, and use the tax savings to pay down the mortgage. Read more: RRSP v. paying down your mortgage: Why not do both?
Contribute to a spousal RRSP to equalize incomes in retirement
Share and share alike. I think that the soul who first spoke these words was actually a Canadian looking to keep a lid on the family tax bill. I’m talking about one very effective strategy: splitting income with your spouse or common-law partner. You see, in an ideal situation, you and your spouse should have equal incomes during retirement (and prior to retirement for that matter). This keeps the total family tax bill at a minimum. The most practical tool for accomplishing this splitting of income is a spousal RRSP. A spousal RRSP is simply one that you will contribute to, but that your spouse will make withdrawals from. You’ll get a deduction for making the contribution, but your spouse, being the annuitant, will pay the tax on any withdrawals.
How’s that for moving income directly from one spouse to the next? Let me share with you a few facts and strategies surrounding spousal RRSPs.
Our tax law has been designed to avoid abuses of spousal RRSPs. To this end, any withdrawals your spouse makes from a spousal RRSP will actually be taxed in your hands to the extent you made contributions to a spousal RRSP in the year of withdrawal or in the previous two years.
For example, if your last contribution to a spousal RRSP was $5,000 in 2008, and your spouse withdraws $7,000 from a spousal plan in 2010, the first $5,000 of that withdrawal will be taxed in your hands since that’s the amount of the withdrawal that can be attributed to contributions you made in the year of the withdrawal or the previous two years. To avoid this attribution, the withdrawals will have to wait until the third calendar year after you make your last contribution.
Keep in mind that you won’t be entitled to additional RRSP contribution room to contribute to a spousal RRSP.
That is, the total contributions to your own RRSP and to a spousal RRSP combined must be within your annual contribution limits. If you exceed your limit, you’ll generally be able to withdraw the excess tax-free, but you’ll face a penalty of 1 per cent per month on the excess contribution until you withdraw it a spousal RRSP was $5,000 in 2008, and your spouse withdraws $7,000 from a spousal plan in 2010, the first $5,000 of that withdrawal will be taxed in your hands since that’s the amount of the withdrawal that can be attributed to contributions you made in the year of the withdrawal or the previous two years. To avoid this attribution, the withdrawals will have to wait until the third calendar year after you make your last contribution.
