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As you near retirement, some kinds of insurance are no longer needed. Income preservation becomes a big focus, so some people consider buying annuities or long-term care insurance. (Andreas Kaspar)
As you near retirement, some kinds of insurance are no longer needed. Income preservation becomes a big focus, so some people consider buying annuities or long-term care insurance. (Andreas Kaspar)

Tax Matters

When advance RRSP donations make sense Add to ...

Tim Cestnick is managing director at WaterStreet Family Wealth Counsel and author of 101 Tax Secrets for Canadians.

Last weekend I visited my grandmother to introduce her to the Internet. The first thing I showed her was the popular website "Ask Jeeves," and told her that it could answer any question she cared to ask. Grandma was very skeptical. "Really, Grandma," I said. "Go ahead and ask a question." As I sat poised over the keyboard, she thought for a minute. Then she responded, "How is your Aunt Judy feeling today?"

Not all seniors are comfortable with computer technology. Well, how about some tax technology? There's an idea I want to share that can potentially save a senior thousands of tax dollars if his or her circumstances fit the bill. Let me explain.

THE IDEA

If you're a senior today, you're probably aware of the rules that require you to wind up your registered retirement savings plan (RRSP) by the end of the year in which you turn age 71. That's right, the government will not allow you to keep your RRSP around forever; eventually you've got to start making withdrawals of those dollars inside your registered plan. You've got a couple of options related to your RRSP when it matures, and if you turned 71 in 2009 you've got just a couple of weeks left to make your decision.

Most seniors choose to convert their RRSPs to registered retirement income funds (RRIFs) by the end of the year they turn 71. One thing is clear: You will no longer be able to make a contribution to your own RRSP after 2009 if you turned 71 in 2009. If you're in this boat, does this mean you have to give up claiming RRSP deductions after 2009? No! You can continue to make contributions to a spousal RRSP if you have unused RRSP contribution room, and provided your spouse is younger than you and is still entitled to have an RRSP.

But there's another idea as well. It's called the "RRSP advance contribution." It works wonders if you've turned 71 this year, but still have "earned income" (income from employment, self-employment, or net rental income, for example) in 2009.

Let's suppose that you are 71 this year, and you earned $122,223 or more in 2009. That earned income will provide you with $22,000 of RRSP contribution room next year (the maximum RRSP contribution in 2010). The problem? You won't have an RRSP to contribute to in 2010. So, is there a way to take advantage of that RRSP contribution room for 2010 somehow? Yes. You can simply make that contribution this month, just prior to winding up your RRSP this year.

If you've already maximized your RRSP contributions in 2009, this $22,000 contribution will be considered an overcontribution to your RRSP in this month. The penalty for this is 1 per cent of the excess contribution per month. So, for the month of December 2009, the penalty will be $200 (you're allowed a $2,000 overcontribution without a penalty). The good news is that the penalty will apply for the month of December, 2009 only, because you'll be entitled to more RRSP contribution room on Jan. 1, 2010, thanks to your earned income in 2009. This puts an end to the penalties.

Follow me? Even though you're not allowed to have an RRSP after this year if you turned 71 in 2009, you can still accumulate RRSP contribution room if you have earned income. Strange, I know, but it's the way our tax law works.

THE BENEFITS

So, why bother with this advance contribution? Simple. You'll be entitled to a tax deduction in 2010 for the $22,000 RRSP contribution. This will save you taxes of $10,210 if you're in the highest tax bracket in Ontario, for example. So, you'll save $10,210 in taxes, and all it will cost you is a $200 penalty for December, 2009.

You might take this even further. What if you expect to have the same earned income in 2010? This will provide you with RRSP contribution room in 2011. You might consider making your 2011 RRSP contribution in December, 2009, as well. This would result in total overcontributions of $44,000 if you made another $22,000 contribution for 2011. You'd have total penalties of $2,820 from December, 2009, to December, 2010, but your tax savings would amount to $20,420 ($10,210 for each of 2010 and 2011, if we assume the same marginal tax rates for those years).

Keep in mind, your excess contribution this month should not be greater than your expected RRSP contribution room in the future.

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