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EXPERT OPINION
Nine ways to save on taxes using RRSPs
JIM YIH
The deadline for tax-deductible RRSP contributions is coming up, and while you consider your investments, don't forget the potential tax-planning benefits as well. Here's how to get the most out of your RRSP:
Know your marginal tax rate
One of the most important benefits of the RRSP is the tax deduction for the current tax year. While most people put money into an RRSP to save tax, many do not know how much tax they are saving.
The easiest way to determine the benefit of your RRSP contribution is to know what your current marginal tax rate is when you combine the federal and provincial taxes.
For example, let's look at Jack and Jill. Jack makes $45,000 a year and Jill makes $85,000 a year and they both invest $1,000 into their RRSPs. Even though they put the same amount into the RRSP, Jill will get a better tax savings - 36 per cent - because she is taxed at a higher rate. Jack would get a 32-per-cent savings.
Make your maximum allowable contribution for 2005
You can contribute 18 per cent of your "earned income" in 2005, or $16,500, whichever is less (if you're a pension plan member, your maximum contribution may be reduced by a figure known as the pension adjustment, or PA).
Watch your tax bracket threshold. If you're making a large RRSP catch-up contribution, consider claiming only enough of the resulting deduction to reduce your taxable income in the higher tax bracket.
You can carry forward the remaining deduction for greater tax savings in a future year against income that is taxed in higher tax brackets.
Start early
Rather than waiting until the next deadline, consider making your 2006 contribution now, or as early as you can, to begin accumulating tax-free income on the contribution as soon as possible.
You will be able to contribute 18 per cent of your "earned income" in 2006, or $18,000, whichever is less.
Understand investment income
Consider holding more conservative investments such as guaranteed investment certificates and bonds that create interest income inside your RRSP.
Alternatively, hold investments that produce tax-preferred investment income, such as capital gains and dividends, outside the RRSP.
Consider a spousal RRSP
If you expect your spouse's retirement income to be lower or higher than yours, then a spousal RRSP may be the best form of future income splitting.
The spousal RRSP will allow the higher income earner to move retirement income into the spouse's account and thus save money on future tax.
Using a spousal RRSP requires planning - don't wait until it is too late. If you don't have a spousal RRSP, when retirement comes and you want to withdraw money, you will not be able move money between the accounts.
Consider a self-directed RRSP
This allows you to hold all your RRSPs in one account. It will give you a broader range of investment options and provide a better way to organize and manage your RRSP portfolio under a consolidated umbrella.
While there may be a cost to holding a self-directed account, there are many benefits.
Typically, the annual cost (trustee fee) of a self-directed RRSP can be rationalized with accounts totalling more than $25,000.
Make monthly contributions
Doing so has many documented advantages.
Dollar cost averaging - the practice of regularly investing a fixed dollar amount into your RRSP, usually through a payroll deduction or pre-authorized chequing - is one of the best ways to create a forced investment plan.
Dollar cost averaging provides three main benefits. From a financial perspective, it is simply a technique to force a systematic disciplined savings plan. From an investment perspective, it can help you to buy more units when prices are low and fewer units when prices are high.
From a tax perspective, you will make sure that you take advantage of tax deductions each and every year.
Utilize foreign investments
The government has made drastic changes to the foreign-content limit. You can now hold as much as 100 per cent of your RRSP in foreign investments.
At a time when Canadian markets are doing better than foreign markets it is important not to lose sight of the importance of global diversification. Despite elimination of the foreign content restriction, experts suggest that you hold only up to 30 per cent of your RRSPs globally. At one time, if you wanted to invest more money outside the country, you had to do it outside of the tax sheltered RRSPs. Now, you can do it all within the RRSP.
Use an RRSP loan
Take out a loan if you don't have the cash. With interest rates at all time lows, such loans may be one of the best deals around.
Would you borrow money at 4 or 5 per cent in order to get a tax savings of at least 25 per cent on your contribution amount? Yes, you would.
Jim Yih is an Edmonton-based financial adviser and author of Mutual Fundamentals and Seven Strategies to Guarantee Your Investments.
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