By Jim Yih
An RRSP is a great way to save for retirement and cut your tax bill, but there are other ways you can use your RRSP to achieve your goals.
For most people, an RRSP is a way to save for retirement and pay less income tax. Although RRSPs remain a great tool for retirement planning, there are some other really useful things you can do with your RRSP. Check out some of the other ways you can use your RRSP to achieve your financial goals:
1. Buy your first home with the RRSP Home Buyers’ Plan
One of the great features of RRSPs is the ability they give first-time home buyers to co-ordinate their RRSP strategy with their home purchase. Under the Home Buyers’ Plan, you and your spouse can essentially each borrow up to $25,000 from your RRSP to buy your first home. For example, Melissa would like to buy a home in five years. She is planning to save about $20,000 for a down payment by putting away $300 per month.
If Melissa puts that $300 per month ($3,600 per year) into an RRSP (assuming she has the contribution room), she will get a 36% tax savings based on her marginal tax rate, which works out to a tax refund of $1,296 per year. In five years, Melissa will have not only $20,000 in her RRSP to borrow for the purchase of her first home, but also an extra $6,500 from tax savings.
When you borrow money from your RRSP under the Home Buyers’ Plan, you must pay the money back over a 15-year period. In Melissa’s case, she has to put back $1,333.33 per year for 15 years; if she misses a payment, she must pay tax on that amount. She will also miss out on 15 years of tax-sheltered growth on that $20,000.
2. Go back to school with the Lifelong Learning Plan
Not only can an RRSP be used for retirement or to buy your first home, it can also be used to fund your or your spouse’s education under the Lifelong Learning Plan. Similar to the Home Buyer’s Plan, any withdrawals for the purpose of training or education are tax free, provided you use the government form RC96.
Zoe took a six-month leave of absence from work to upgrade her education, and decided to borrow the annual maximum of $10,000 for two years from her RRSP, for a total of $20,000, to pay for it. She must repay her RRSP over a period of no more than 10 years ($2,000 per year). If she misses an annual payment, that amount will be added to her income for that year and thus be taxed at her marginal tax rate. And again, she will miss out on the tax-sheltered growth that the $20,000 would have earned had she left it in her plan.
3. Split your income with a spousal RRSP
Splitting income between yourself and your spouse is a great way to reduce taxes. There are two ways to accomplish this using an RRSP.
First, you can contribute to a spousal RRSP. Jack has an annual RRSP limit of $10,000. He can contribute that either to his personal RRSP or to that of his wife, Jenna (who has a significantly lower income). If he contributes to Jenna’s RRSP, he will get the tax deduction at a higher rate than Jenna would by contributing to her own. When they take the money out in retirement, they can each withdraw from their own RRSPs, resulting in less tax owing overall than if Jack was to claim the full amount at his higher rate.
The other way to split RRSP income is after the age of 65. Let’s say Mark is 72 and is now starting to create income from his RRSP through a registered retirement income fund (RRIF). For those 65 years of age or older, any RRIF income is considered pension income for tax purposes; if Mark’s spouse is in a lower income bracket, Mark can reduce his income tax bill by moving up to half of that income (but not the RRIF itself) to his spouse.
4. Reduce tax deductions at source
Many people who contribute to RRSPs either throughout the year or right before the deadline wait until they file their tax returns to claim their RRSP tax deductions and get their refunds.
Although getting that refund feels pretty good, what you’re actually doing is giving the government an interest-free loan with your hard-earned money. That’s pretty generous of you.
To avoid that, you can contribute via payroll deduction to a workplace plan (if your employer offers one), and the necessary adjustments to the tax deducted will be made at source. Sarah has an RRSP that’s not through her employer; she files a request with the Canada Revenue Agency and arranges for her employer to deduct less income tax from her paycheque. In either case, the tax refund is effectively spread out over the whole year and the tax savings – which can be reinvested – is available sooner.
5. Make in-kind contributions to your RRSP
Often, people contribute to their RRSPs directly with cash – but you may not be limited to cash contributions. Instead of coming up with cash or liquidating investments to make RRSP contributions, Jacob sometimes prefers to transfer bonds, mutual funds or stocks in kind or “as is” from his non-registered investment account to his RRSP, which permits in-kind contributions. (Check your RRSP rules; not all plans allow this strategy.)
It’s important to remember that when you transfer an investment such as stocks or bonds into an RRSP, it’s still considered a taxable disposition and you may have to pay capital gains tax if the value of your investment has gone up. If the value of your investments has gone down, though, keep in mind that you cannot claim a capital loss for in-kind contributions to a registered plan.
6. Use the RRSP over-contribution limit
In 1995, the government reduced the one-time over-contribution limit to $2,000 from $8,000. The over-contribution limit is really designed to provide a buffer in case you make a mistake in calculating your RRSP contributions.
Some people purposely over-contribute up to the limit, however, to get ahead of the game and take advantage of tax-deferred growth and compounding in their RRSPs. But as you get closer to retirement and the need to make withdrawals, you should make sure that you eventually claim that $2,000 as part of your contribution limit to avoid double taxation. Be aware, too, that if you exceed the $2,000 buffer, you will be liable for a 1% per month penalty until you withdraw the excess.
Whether you use any of these tactics to leverage your RRSP, or simply stick to saving for your retirement, the key to success is to get started now, and make saving a habit.