Six Cool Things

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Judging from my inbox, a lot of people are blissfully unaware you don’t need money to make an RRSP contribution and score a tax refund. I wrote here yesterday about dithering Jenny and her dead-end GIC. When we shifted it into an RRSP, she lined up to get 30% of it back in cash, which could then go into a TFSA. It’s as close as we get to magic in this cold, depressing country full of ice and unrequited desire.

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A contribution in kind is simple, effective and quick. It takes an asset you own which is taxable and makes it non-taxable, while the government pays you for doing so. The growth then happens with no tax consequences, until you collapse the RRSP at some point in the future. But if you do it in an intelligent fashion, that tax load can be minimal.

(One caution, of course. If you move a mutual fund or stock or ETF or anything into your RRSP which has risen since you bought it, a capital gain will be triggered. But fear not. Cap gain taxes are cheap since one-half of the gain is tax-free. For most people this will amount to 15% or the profit, while you get to keep 85%. The rest of life should be so fair.)

Well, it’s just a shame most people will make no RRSP contribution this year and sadder still that those who do will average a pathetic $3,200. This is an important little tool in your financial arsenal with some worthy applications. Remember you have until the third of March to put money in for a refund on 2013 taxes, and it can equal 18% of what you earned last year. And while I know on the Sexiness Scale RRSPs rank somewhere between cold sores and living in Saskatoon, here are six cool things to do with them.

1. Shift taxation within your life.
This is easy. During years when you are gainfully employed, contribute to an RRSP, deduct this amount from your taxable income, get a refund and invest that outside your plan. Then during those times of your life when you are fired, laid off, punted, outsourced, severed, displaced, rightsized or just general screwed by The Man, you can cash in the RRSP, live off the money it contains, and pay little if any tax while doing so. What you’ve done is build up your own emergency reserve, and at the same time shifted the tax burden from the years of employment to the period of freedom.

2. Split income with your spouse
Now, here’s an excellent use for your spouse. If you earn more than him or her, or your spouse plans on taking time off, or is older and due to retire sooner, or a babe still in school, then open a spousal plan. The law allows you to contribute into a plan for your spouse up to your own contribution limit. You get to deduct the funds from your own taxable income, but they become the property of the other person. After three years in there, the money can be accessed by your spouse (so choose carefully) and used for whatever, and is taxed at their rate – presumably lower than your. So, you have income-split. Just be careful no money is taken before the three years or it will be attributed back to you, and cause a giant, ugly domestic dispute.

3. Finance a kid
Speaking of a spousal plan, one of the best uses of RRSP money is to pay the household expenses during a mat leave. If a spousal plan is in place, your squeeze can cash it in (ensure each withdrawal is less than $5,000 to minimize the withholding tax), and use the money to replace lost income. Of course, to make this work efficiently, you will need to plan the pregnancy at least three years in advance with the mat leave commencing on January 1st. Piece of cake. Here’s a calendar.

4. Upgrade your skills.
Rules also permit you to raid your RRSP to go to school, or send your spouse there. The Lifelong Learning Plan allows $10,000 a year to be taken, to a max of twenty grand (or forty between two spouses). Then, after school’s done, you have 10 years to put the money back into your plan. If you don’t, it will be added to your taxable income annually. This sure beats paying a bank interest on a tuition loan. Plus, you can put money into your RSP, get a tax refund for doing so, then turn around and take it out for school.

5. Buy a house (dubious), and lever your downpayment (better).
Ditto for the Homebuyers’s Plan. Up to $50,000 can be taken from the RRSPs of you and your spouse for the purpose of buying your first home. Then you have 15 years to repay it, starting in the second year after the withdrawal. Don’t make the annual payments, and the bucks will be added to your income and taxed at your marginal rate. While buying a home is a bad idea right now in many cities, and while the HBP actually has no inherent benefit to it, it does allow you to lever a bit. For example, if you both took your $50,000 down payment and RRSP’d it, leaving it there for just 90 days, you might get a refund of $15,000 which can be used at closing to reduce the mortgage. But, knowing you, it’d go into a hot tub upgrade.

6. Generate a tax refund which you promise not to piss away in Aruba.
That should be obvious. Invest extra cash in an RRSP, get a refund cheque and put the money into investments inside your TFSA. This is called revenge. It tastes good.

Bonus thing to do with an RRSP: retire.
Yes, I know this is exactly why the thing was invented 60 years ago, and I’m quite aware the mama of all retirement crises is now just a few years away, since seven in ten people no longer have a viable company pension. But the TFSA is emerging for anyone under 35 as the retirement vehicle of choice – so long as you keep it fully funded each year, and invested for growth. Still, there is a role for RRSPs, since money can grow inside these suckers tax-free until you turn into a hideous wrinkly with glass ankles. Then you can bitch and moan about the tax you pay collapsing them.

At least it’s something to do.

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avatarGarth Turner - The Greater Fool posted Monday, January 27th, 2014.

2 Comments for “Six Cool Things”

  1. If I went back to school I would pull all the RRSPs I could while I had no income. Does anyone beat inflation investing? Will you be paying more or less tax in coming years? Will those dollars still have the same purchasing power as when they were put in? The Greater Fool is us?

  2. Retail Investor
    avatar

    I disagree with some of the author’s points.

    1) Withdrawals in years when your income is low will indeed allow it to be taxed little if at all …. BUT the benefit from a lower tax rate on withdrawal is only one benefit from the RRSP. The greater benefit comes from income-sheltering from tax …

    You will then have destroyed contribution room that could have sheltered income from tax for the next 50 years. Maybe you have decided that you will never be able to save enough to maximize the allowed contribution anyways. Maybe you have decided that Aunt Molly will never leave you that legacy that would benefit from income-sheltering. Maybe you have decided that you will never get ahead in your job and earn highly taxed income in the future. Maybe you have decided that you will never marry someone rich whose assets could be income-sheltered.

    Are you sooooo negative on your life?

    2) The tax refund/reduction on contribution is not “as close as we get to magic”. The tax reduction is a loan from the government that you must pay back on withdrawal ..along with all the income it earned. Think of it like your best friend Bob giving you his money to invest on his behalf. His money makes up some % of the account total to start. All the profits it earns are his. At no time do you consider the whole account to be ‘your own’. You face no benefit/cost from the arrangement because on withdrawal you must give Bob back his % of the account. The taxes paid on RRSP withdrawals are an allocation of principal, not a delayed tax on the profits earned.

    You never contribute ‘to get the refund/reduction’. There is no benefit from the reduction.

    Take a gander at http://www.retailinvestor.org/RRSPmodel.html

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