January 24, 2018

Maximizing RRSP vs Minimizing Taxes

Contrary to popular belief, maximizing your RRSP may not always be synonymous with minimizing your taxes. Sure, your contributions will bring down your taxable income in the short run and you probably will get a refund soon, once you file your tax return. But after all is said and done, you may also end up paying more tax.

The good news is that, as far as RRSPs are concerned, fairly simple fiscal planning can go a long way. The key is to compare your present (or contribution) tax level with your probable withdrawal tax level.

Because taxes increase with your income level, ideally, you want to contribute when your income is high and withdraw when it is low. In the same fashion, you want to avoid unnecessary contributions when your income is abnormally lower and limit withdrawals in periods where your income is higher.  

Therefore, it may not be a good idea to maximize your RRSP this year if your income level is low or lower than normal. Hence, if you have money to invest in a lower income year, putting it in your TFSA may be a better alternative.

In that sense, we’ve already discussed why and how we are Preparing to Take Assets Out of RRSP, utilizing our TFSA instead. A post coming to you soon (probably in March) discussing the Home Buyers Plan (HBP) will basically talk about variations around the same theme

In the end, finding your ideal tax bracket may be the fundamental secret.

Relatively low-income earners like me will essentially fiddle around the basic tax bracket. For 2017, that federal tax level is above 45916$. Similar provincial tax levels are, for example, over 42201$ for Ontario and 42705$ for Quebec.

Profitable RRSP Adjustments

Adjusting your RRSP contributions every year can be very profitable in the long run. To be illegible to be deducted in the previous tax year, contributions must be done before the end of the first 60 days of the year. We suggest doing it a little earlier to avoid last-minute hassle around the dreadful RRSP deadline (February 29th or March 1st).  

Most of the time, the objective will be to push your income back just enough to get to a lower tax bracket. That strategy will maximize your tax savings. Any additional contribution beyond that tipping point would be pointless or at least, not as advantageous.

Your taxable income is calculated at line 260 on your federal tax return. Roughly, on top of RRSP considerations, it will take into account your employment income less some deductions like your pension fund contributions.

In today’s digital world, you can easily use a tax software for all necessary calculations. Most of them can even propose optimal scenarios that will also take into consideration corresponding provincial implications.

Just remember that in some cases, like ours, bringing your taxable income up (instead of down) may be an interesting viable option in lower income years. Paying taxes now in lower tax bracket will enable you to somewhat avoid the ill-effect of a higher tax bracket when withdrawal time comes by later.

Unfortunately, our taxation system is a tad complex. This means you also must consider consequences of taxable income increases on other programs like child benefits. Thus, in our situation this year, we have to account for an indirect tax of 3.2% that would amputate what we will receive from the Canada Child Benefit program. In the end, that’s what stopped us from pulling the trigger on an RRSP withdrawal so far. Our girl is growing up fast (Snif!) and we still will be able to profit even more from our recent withdrawal strategy a couple years down the road.

Important final note: unlike its RRSP contribution counterpart, the RRSP withdrawal deadline is December 31st. So, remain careful and plan ahead to avoid your withdrawals ending up in the wrong fiscal year. Also account for a couple business days for the operation to settle.

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