The Swiss Army Knife is a tool with one large blade and other multi -purpose functions. Similarly your RRSP is a Financial tool with one large blade; (retirement savings and tax savings) but it too is multi-functional with many other features. Let’s check out some of the other useful thangs that you can do with your RRSP.
Buy Your First Home – RRSPs give first-time home buyers the ability to co-ordinate their RRSP strategy with their home purchase. Under the Home Buyers’ Plan, you and your spouse can each borrow up to $25,000 from your RRSP to buy your first home. For example if you plan to buy a home in five years you can save about $20,000 for a down payment by putting away $300 per month. Putting $300 per month ($3,600 per year) into an RRSP will get you 36% tax savings based on marginal tax rate, which works out to a tax refund of $1,296 per year. In five years, you will have not only $20,000 in the RRSP to borrow for the purchase of the first home, but also an extra $6,500 from tax savings. Of course, the precise numbers will depend on your specific rate of return and marginal tax rate. When you borrow money from your RRSP under the Home Buyers’ Plan, you must pay the money back over a 15-year period. In the above case, you have to put back $1,333 per year for 15 years. If you miss a payment, you must pay tax on that amount and you will also miss out on 15 years of tax-sheltered growth on that $20,000.
Go Back to School – Your RRSP can also be used to fund your or your spouse’s education under the Lifelong Learning Plan. Similar to the Home Buyer’s Plan, any withdrawals for the purpose of training or education are tax free, provided you use the government form RC96. You can borrow an annual maximum of $10,000 for two years from your RRSP, for a total of $20,000, You must repay the RRSP over a period of no more than 10 years ($2,000 per year). If you miss an annual payment, that amount will be added to your income for that year and thus be taxed at your marginal tax rate.
Split Income With Your Spouse – Splitting income between yourself and your spouse is a great way to reduce taxes. There are two ways to accomplish this using an RRSP. First, you can contribute to a spousal RRSP. For example, Jack has an annual RRSP limit of $10,000. He can contribute that either to his personal RRSP or to that of his wife, Betty (who has a significantly lower income). If he contributes to Betty’s RRSP, he will get the tax deduction at a higher rate than Betty would by contributing to her own. When they take the money out in retirement, they can each withdraw from their own RRSPs, resulting in less tax owing overall than if Jack was to claim the full amount at his higher rate.
The other way to split RRSP income is after the age of 65. Let’s say Jack is 72 and is now starting to create income from his RRSP through a registered retirement income fund (RRIF). For those 65 years of age or older, any RRIF income is considered pension income for tax purposes; if Jack’s spouse is in a lower income bracket, Jack can reduce his income tax bill by moving up to half of that income (but not the RRIF account itself) to his spouse.
Reduce Tax Deductions at Source – Many people who contribute to RRSPs either throughout the year or right before the deadline wait until they file their tax returns to claim their RRSP tax deductions and get their refunds. Although getting that refund feels pretty good, what you’re actually doing is giving the government an interest-free loan with your hard-earned money. To avoid that, you can contribute via payroll deduction to a workplace plan (if your employer offers one), and the necessary adjustments to the tax deducted will be made at source. However, this strategy is not for everyone. If you tend to simply spend your extra money at payday rather than reinvest you may simply be better to wait for your lump sum refund in the spring
Use the Over contribution Limit – In 1995, the government reduced the one-time over-contribution limit to $2,000 from $8,000. The over-contribution limit is really designed to provide a buffer in case you make a mistake in calculating your RRSP contributions. Some people purposely over-contribute up to the limit, however, to get ahead of the game and take advantage of tax-deferred growth and compounding in their RRSPs. But as you get closer to retirement and the need to make withdrawals, you should make sure that you eventually claim that $2,000 as part of your contribution limit to avoid double taxation. Be aware, too, that if you exceed the $2,000 buffer, you will be liable for a 1% per month penalty until you withdraw the excess.
Whether you use any of these tactics above remember to use the big blade in the RRSP tool; to save for retirement in a tax advantaged manner.