More last-minute RRSP contribution tips
What, when and how to contribute
The deadline for 2020 RRSP contributions is right around the corner, on March 1. Have you contributed this year? Even a few bucks? Last time, I offered a couple of tips for making the most of RRSP contributions, including using spousal plans and making catch-up contributions. In this article, I have three more tips to help you make the most of your RRSP.
1. Put the high-tax stuff in your RRSP
It has been said that you should hold high-tax investments in your RRSP and low-tax investments outside your plan. But which investments are high tax? Traditionally, these have been interest-bearing investments. Stocks and equity funds, on the other hand, may qualify for capital gains treatment (50% of a capital gain is tax-free) as well as the dividend tax credit if Canadian. These benefits are lost if you hold certain investments through your RRSP, since retirement and other amounts you receive from your plan are fully taxable. So, if you have investment capital both inside and outside your RRSP and you wish to invest in both equities and fixed-income investments, it is generally better to hold the former outside your RRSP and the latter inside your plan.
Can equities be high tax? A case in point arises if you’re contemplating a big short-term capital gain. In this case, the equity investment could, in effect, become high tax, since you have to pay this tax for the year you sell, while the gain can be tax-deferred in your RRSP. Holding equities you intend to trade frequently in your RRSP could defer capital gains tax for years – giving you the opportunity to take profits and reinvest on a tax-deferred basis. In some cases, this may more than make up for the tax breaks you get by holding outside your RRSP.
It may make sense to hold part of a high-appreciation equity position – the portion you may liquidate – in your RRSP. (Careful though: Transferring existing investments into your RRSP triggers capital gains tax, if they’ve appreciated in value.)
If an equity is a long-term hold, the “outside-the-RRSP” strategy still applies.
Finally, it makes little sense to select your investment portfolio just to get the tax benefits. For example, if you like an equity investment, then by all means invest through your RRSP if that’s where your capital is.
2. Building in contribution room for your family
If you carry on a business, it may be that you are paying your children a salary. If so, this not only creates contribution room for your kids but also results in a deduction for your company. (Make sure the salary is not unreasonably large in light of the services they are actually providing the business.) Every person (including children) can receive up to $13,808 for the 2021 year without paying tax by claiming the federal basic personal tax credit. Moreover, the salary your child receives should qualify as “earned income,” so that he or she will be entitled to make an RRSP contribution based on 18% of the salary, something that can be carried forward over the years.
For example, if you have two children and pay each child $13,000 a year for 10 years, and this was their only income, no tax would be paid. However, each child would then be eligible for a tax writeoff of $23,400 over the 10 years because of the RRSP carryforwards (remember, they contribute 18% of their annual earned income each year), which could be used to reduce their taxes when they have higher income. So your two kids, together over the 10 years, could be in a position to claim writeoffs of $46,800 – and your business would also have enjoyed some writeoffs in the meantime.
3. Don’t wait to contribute
Okay, this tip is pretty obvious, especially if you haven’t yet contributed you have only a few days left to make a contribution to get a 2020 tax deduction. But you’d be surprised how many people wait until the end of the last day to contribute. But, if you happen to have already made your contributions for the year, this tip is still worthwhile because there’s no time like the present to start contributing to your 2021 RRSP. If you have the cash available now, don’t wait until February 2022 to make your contribute 2021 contribution. Why pay tax on your interest income while it sits in your bank account when your income could be tax-sheltered in your RRSP?
Samantha Prasad, LL.B., is a Partner with Toronto law firm Minden Gross LLP, a Meritas Law Firm Worldwide affiliate, and specializes in corporate, estate, and international tax planning. She writes frequently on tax issues, and is the co-author of Tax and Family Business Succession Planning, 3rd Edition. She is also co-editor of various Wolters Kluwer Ltd. tax publications. This article first appeared in The TaxLetter, © 2021 by MPL Communications Ltd. Used with permission.
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The foregoing is for general information purposes only and is the opinion of the writer. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.