I asked my friend, Michael, if he plans to contribute to his registered retirement savings plan this year. He said “Tim, I’m stuck between ‘I need to save money’ and ‘you only live once.’” In the end, Michael agreed that saving for retirement is a noble pursuit. Then we talked about some tips for making the most of an RRSP. I want to share those with you now.
Get your asset location right. I often see people holding investments in the wrong types of accounts – that is, in the wrong location. To the extent you have interest-bearing investments in your portfolio, hold those assets in your RRSP where they will be tax-sheltered. After all, interest income is taxed at the highest rate going for your given tax bracket. If you still have room in your RRSP after holding these interest-bearing investments inside the plan, then go ahead and hold some of your equities in the plan as well.
Avoid withdrawals for short-term debt. I’ve seen many people make withdrawals from RRSPs to pay down short-term debt. The problem? You’ll likely pay more in tax on the withdrawal than you’ll save in interest costs. If you were to make a withdrawal of $10,000 from your RRSP, for example, and had a marginal tax rate of 30 per cent (not far off for the average Canadian) you’d pay taxes of $3,000 on that RRSP withdrawal, leaving you with just $7,000 to pay down your debt. You’d be better off not making the withdrawal if the debt would otherwise be paid off in six years or less, if your debt incurs interest at 6 per cent. If your debt incurs interest at, say, 19 per cent (credit card rates), you’d be better off not making the RRSP withdrawal if you’d otherwise pay off that debt in two years or less. Making tax-free withdrawals from your tax-free savings account (TFSA) could make sense for paying down debt instead.
Don’t contribute your losers. If you’re thinking of contributing in-kind to your RRSP, make sure you don’t contribute investments that have declined in value. You’ll be deemed to have sold those investments at fair market value if you make a transfer to your RRSP, but your capital loss will be denied under the superficial loss rules. Your best approach is to sell those losers then contribute the cash to your RRSP. This way, you’ll be able to claim the capital loss. And once the funds are inside your RRSP, avoid repurchasing the same investment within 31 days following the sale, otherwise your capital loss will be denied under another superficial loss rule.
You can contribute your winners to your RRSP if you’d like. This will trigger a taxable capital gain on the investment, but would also give rise to an RRSP deduction (as with any contribution). Provided you have sufficient contribution room, the deduction will more than offset the taxable capital gain, so there would be no tax arising in this case.
Claim your deduction in the right year. If you contribute to your RRSP within your contribution limit, you’ll be entitled to a deduction on your tax return – but you don’t have to claim that deduction in the year you make the contribution. You can claim it in any future year if you’d like. It could make sense to defer your RRSP deduction for a year or two if you expect your income to increase, pushing you into a higher tax bracket and subjecting you to a higher marginal tax rate. If, for example, you earned $75,000 in 2019, and live in Ontario, a $10,000 RRSP deduction will save you $2,965 since your marginal tax rate is 29.65 per cent. If you expect your taxable income to increase to, say, $100,000 this year, that same deduction will save you $3,838 (almost 30 per cent more) if you claim it in 2020 instead.
Monitor your beneficiary designation. It’s a smart idea, every once in a while, to revisit the named beneficiaries of your RRSP (or registered retirement income fund) – particularly if you separate or divorce. The beneficiaries you’ve named on your RRSP or RRIF account documents are not revoked in the case of a marriage breakdown. I’ve seen cases where a former spouse became entitled to RRSP or RRIF assets because the account owner forgot to make a change to the named beneficiary after the divorce. Even if you haven’t gone through a marriage breakdown, it makes good sense to revisit your named beneficiaries periodically – just as you should be revisiting your will.
Don’t combine spousal and non-spousal plans. If you have both a spousal RRSP and non-spousal RRSP, be aware that if you combine those accounts at some point, all the money in the combined account becomes “spousal” RRSP dollars. These dollars are then subject to the rules that could cause some withdrawals from the spousal RRSP to be taxed in your spouse’s hands to the extent your spouse has made contributions to a spousal RRSP in the year of the withdrawal or the two prior years. You generally want to avoid attribution of RRSP withdrawals back to the contributing spouse because that is typically the higher-income spouse.
Tim Cestnick, FCPA, FCA, CPA(IL), CFP, TEP, is an author, and co-founder and CEO of Our Family Office Inc. He can be reached at firstname.lastname@example.org.