Now’s the time to plan your RRSP strategy

Don’t wait until next February

Many investors only think about their Registered Retirement Savings Plan (RRSP) in February. But that’s really just a conditioned reflex, spurred on by financial institutions to get you to give them money in the first 60 days of each year. Any contribution made within those 60 days can be applied to the previous year and is deductible from your previous year’s income. That’s all well and good, but your RRSP really needs more attention than a panicky annual deposit just before the deadline.

A better alternative is to start thinking about your RRSP contribution now. You have lots of time to weigh the pros and cons, consult with your financial planner, and come up with some cash to contribute.

Why RRSPs are still so attractive

Basically, an RRSP lets you contribute 18% of “earned income” every year to a pre-set maximum. For 2020, the maximum contribution limit is set at $27,230. And the last day to make a contribution for the 2020 tax year is March 1, 2021. In addition, you can carry forward any unused contributions from 1991 on and use them as well.

One of the big incentives for RRSP contributions, especially for higher net worth individuals, is that you get a tax deduction for your contribution for a given year. If your RRSP tax deduction results in a tax refund, you can leverage that refund by reinvesting it right back into your RRSP to keep that compound growth working for you. If you are in a higher income range, begin at age 40, and contribute, say, $20,000 per year for 25 years. At an 8% return, you’ll retire with $1.7 million.)

Remember that your investments grow tax-free while inside your RRSP. You don’t pay tax until you withdraw funds from your RRSP at retirement. Usually you’ll do this by rolling over your RRSP into a Registered Retirement Income Fund (RRIF) or an annuity when your RRSP matures. At that point, you pay tax on income from your RRIF at your full marginal rate, which is typically lower than it is in your peak earning years.

The beauty of an RRSP is that you can put virtually any investment under its tax-deferred umbrella. “Qualified investments” include, for example, cash and GICs, stocks, bonds, exchange-traded funds, mutual funds, options, annuities, mortgages, and even gold and silver. There’s a complete list of qualified investments on the CRA website.

Funding your RRSP contributions

There are several sources of funds you might use for RRSP contributions.

Automatic deposits. Arrange with your bank or your employer (if they’ve set up a group RRSP) to automatically deposit funds to your RRSP with every paycheque. You set the amount. It’s just like any other withholding amount from your pay, except the that this one remains in your hands as an RRSP contribution. And contributing through the year gets your money invested and compounding that much sooner.

Severance payments. If you received a severance payment in 2020, use it to make an RRSP contribution. That way, you’ll shelter some or all of the severance amount from income tax.

Cash accumulation. During the Covid-19 pandemic, many people have found that their discretionary spending has been cut way back. Travel, luxury purchases, even new car purchases have been postponed until things return to normal. In many cases this has resulted in a cash build-up in bank accounts. Consider using some or all of that excess cash to top-up your RRSP contribution. But be careful not to overcontribute, as this can result in penalties.

Inheritances. If you’ve received a substantial bequest in the year, use at least some of it for an RRSP contribution. Bequests themselves are generally not taxable as income, but any investment income from that bequest is. If it’s in an RRSP, investment growth is tax-sheltered until your RRSP matures. Again be careful not to overcontribute or attract the Alternative Minimum Tax by making a large contribution, even if it’s within your limit. Your financial planner can help guide you here.

Contributions in kind. If you have qualifying investments outside an RRSP in a non-registered account, consider transferring some of them to an RRSP. Their current value will be deemed to be the contribution amount for tax purposes. Any qualified RRSP investment will do, but bear in mind that there will be “deemed sale” of the asset you’re contributing, and 50% of any capital gain may be taxed. However, the upside is that you’ll get a tax deduction on 100% of your contribution. To make contributions in kind, you’ll need a brokerage account or have a self-directed RRSP that lets you pick and choose your own investments. Again your financial planner can help.

Borrowing. Some advisors advocate borrowing to make an RRSP contribution, arguing that not only do you top up your RRSP, but you also get a tax deduction and you’ll be able to pay down the loan with your refund. But there are some downsides to consider. The biggest one is that borrowing your RRSP contribution means that you are levering your investment. If you borrow money to invest in equity investments in your RRSP, you run the risk of magnifying any losses that may occur. In other words, the value of your investment may end up being less than the value of your loan. You don’t want to be forced into liquidating RRSP holdings to repay the loan, because you’ll pay tax at your top marginal rate when you withdraw funds from your RRSP.

There’s much more to an RRSP than a quick contribution in February. So don’t wait until the then. Talk to your financial planner now about ways to maximize the power of your RRSP all year round.

Robyn Thompson, CFP, CIM, FCSI, is the founder of Castlemark Wealth Management, a boutique financial advisory firm specializing in wealth management for high net worth individuals and families. Contact her directly by phone at 416-828-7159, or by email at rthompson@castlemarkwealth.com for a confidential planning consultation.

Notes and Disclaimer

The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned are illustrative only and carry risk of loss. No guarantee of investment performance is made or implied. It is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. Please contact the author to discuss your particular circumstances.