The bigger bang theory
Helping your clients maximize their 2019 RRSP contribution.
It’s a leap year in 2020, so clients have until March 2nd1 to make a Registered Retirement Savings Plan contribution that counts towards a tax deduction for the 2019 tax year. But just after the holiday season, many families’ extra cash flow is at a low ebb.
The good news is that your clients don’t have to miss out on the benefits of making a contribution before the deadline. An RRSP loan is the “bigger bang” strategy that can help clients bump up their RRSP contributions at a very low cost – as long as they commit to repaying the loan with their tax refund.
First, let’s review some of the ways RRSPs can help your clients meet their long-term goals:
- Money has the opportunity to grow and compound on a tax-deferred basis from the day it is deposited into an RRSP
- Contributions are tax-deductible and, for people with a higher marginal tax rate, that can mean substantial tax savings when they file their taxes
- Up to $35,000 is available to first-time home buyers through the Home Buyers’ Plan to help with a down payment – the withdrawal is not taxed if it is repaid on schedule
- Up to $20,000 is available to people returning to school through the Lifelong Learning Plan to help with the cost of education – again, the withdrawal is not taxed as long as it is repaid on schedule
One of the best ways to contribute to an RRSP is, of course, through a regular investment plan that sees clients contribute their annual maximum gradually, throughout the year. Smaller contributions don’t seem as overwhelming, and the discipline of a schedule of regular deposits can help clients stick to their savings goals.
However, as financial advisors know better than most, some people find it challenging to commit to year-round savings targeted to maximize their RRSP contribution. A regular investment plan with a smaller fixed contribution amount can give them more wiggle room in their monthly budget, making it easier to implement. Others may prefer making a one-time contribution during the first 60 days of the year, when they know how much money is left over after the year’s expenses. In both cases, they may run short of the funds required to top-up or make their RRSP contribution.
The RRSP loan advantage
That’s where an RRSP loan can be very helpful to clients. “By using an RRSP loan, they can increase their total RRSP contributions and use the tax refund to pay off the loan. The result is they have more money working for them sooner in a tax-deferred plan,” explains John Natale, Manulife’s Head of Tax, Retirement and Planning Services. “How do you calculate an RRSP loan amount that can be completely repaid by the tax refund? There’s a formula: you take the amount of the expected refund before the RRSP loan … and you divide it by one minus [the client’s] marginal tax rate.”
Running the numbers, here’s how that calculation could play out. Assume your client, Nathan, has $7,000 saved and ready to contribute to his RRSP – but he’d like to contribute more because he has $50,000 in RRSP contribution room available. Nathan’s marginal tax rate is 40 per cent, so he expects a tax refund of $2,800 ($7,000 x 0.40) before considering an RRSP loan. The RRSP loan amount that can be completely repaid by the tax refund is $4,667 (= $2,800 / (1 -0.40)).
“Using the RRSP loan, this individual has increased his RRSP contributions to $11,667 [$7,000 + $4,667], and the cost is minimal: the interest on the loan while it is outstanding. If we assume that the loan is outstanding for 90 days, at an interest rate of four per cent, the total cost of the interest is still under $50,” says Natale.
As a point of comparison, without the RRSP loan, Nathan could have contributed his $7,000 during the first 60 days of the year, and then contributed his $2,800 tax refund when he received it. That would have resulted in a total RRSP contribution of $9,800, compared to $11,667 – and only $7,000 of the amount contributed would have had the opportunity to compound on a tax-deferred basis starting during those first 60 days.
This example assumes that your client makes the RRSP contribution in the first 60 days of the year, has sufficient RRSP contribution room available and understands that RRSP loan interest is not tax-deductible. Given all of that, it is a way to help clients get substantially more money working for them sooner within a tax-deferred plan – and, as long as they are disciplined about using the tax refund to pay off the RRSP loan, the price tag is very low.
When choosing an RRSP loan for this strategy, look for a competitive interest rate, a deferred payment option (so payments don’t have to be made before the tax refund comes in) and the ability to make a full repayment anytime without penalty.
Other beneficial RRSP season strategies
Looking for other ways to persuade your clients to take full advantage of RRSP season 2020 to boost their savings?
Clients who will turn 71 in 2020 have the opportunity to make a final RRSP contribution that year if they have unused RRSP contribution room or if they expect earned income in 2020 that will generate RRSP contribution room in 2021. If they make that contribution in the first 60 days of 2020, the related tax deduction doesn’t have to be claimed on their 2019 or 2020 tax return. Instead, they can carry forward the tax deduction and use it to lower a future year’s earned income – which can help them avoid clawbacks on income-tested government benefits and/or qualify for certain tax credits.
For married or common-law clients with uneven incomes, contributions to a spousal RRSP during the first 60 days of the year (or anytime!) can provide a tax deduction for the higher-income earner and allow withdrawals in future years to be taxed in the lower-income earner’s hands provided a spousal contribution hasn’t been made in the year of the withdrawal or the previous two calendar years. That means spousal RRSPs can provide tax savings now and income splitting in the future – making them a valuable tax management tool. Keep in mind that spousal RRSP contributions count towards the contributor’s RRSP contribution room, and also that a client can make contributions to a spousal RRSP until the end of the year the spouse turns 71.
And what about clients who don’t have any RRSP contribution room? Remind them about Tax-Free Savings Accounts, which offer tax-free growth potential with no upper age limit. The 2020 TFSA contribution limit is $6,000; those who haven’t yet opened a TFSA have accumulated a total of $69,500 in contribution room. Now is the perfect time to get as much money as possible compounding tax-free inside a TFSA.
For more information about RRSPs and TFSAs, visit the Tax, Retirement and Estate Planning Services pages on Advisor Portal.