It’s that time of year again!
By Al Ramsay and Orlando Lopez
Several sources suggest Canadians are contributing less to their RRSPs than they used to contribute in the past, and that’s concerning because defined benefit pension plans are fewer, interest rates are at a historic low, and life expectancy is increasing. There are various reasons contributing to this trend: one may be a misunderstanding of how to use RRSPs as a tax planning tool in addition to being a nest egg for retirement. Below, we’ll explain our tax system to help you determine when to contribute, who should contribute, and where to find money for the contribution.
Household tax scenario
A tool can be used efficiently for certain jobs and specific scenarios only (for example, a screwdriver is not effective on a nail). When it comes to RRSPs, the tax benefit is dependent on one’s marginal tax rate, but what does that actually mean? Our example involves a couple named Ellen and Kim, both in their mid-30s. Ellen earned $100,000 in 2016 and is a member of her company’s defined benefit pension, while Kim earned $50,000 and has no pension. Ellen has to pay $25,203 in taxes and Kim has to pay $8,405, which equates to a total household tax of $33,608. In order to reduce their current tax bill, if Ellen makes an RRSP contribution of $25,000, her tax bill becomes $15,852—a decrease of $9,351.
An RRSP contribution saves them money now, but also in the long run. Thanks to her pension, Ellen is on track for a larger retirement income than Kim, but they can achieve a more balanced retirement income for the household if Ellen makes spousal RRSP contributions, allowing her to get a tax deduction now while she is still working. The money withdrawn in retirement from the spousal RRSP will be taxed in Kim’s name at a lower tax rate.
The bottom line is this: from a tax planning perspective, you can use RRSPs to level out your taxable income through time, and level the taxable income between couples in retirement.
The examples above help make it clear that RRSPs are not optimal for everyone all the time. If your analysis results in a decision to make a contribution, you can contribute from your current savings in a TFSA (tax-free savings account) or Non Registered (in kind contribution allows this without liquidating). If you have no savings, then a last resort could be an RRSP loan if the rate is reasonable and if you can envision paying it off within the year. In life we either save up or pay down for things, and it’s better to save towards our goals.
TFSA vs RRSP
If you are saving up for your RRSP contribution, it’s not a bad idea to use a TFSA account to park this money until you decide the exact amount you want to contribute. One reason is because a TFSA is flexible and allows you to take the money out if needed without any tax issues.
The above example is a very brief and simple example; you should consult an accountant and financial planner to review your situation to determine the optimal conditions for contribution to your RRSP. The norm is to do it in years of high income, and by the partner with the higher income.
Finally, it’s imperative to have these conversations first with yourself and your partner to determine how you desire to live in retirement.
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Note: The Canada Revenue Agency treats married and common-law couples (including same-sex couples) the same in regards to spousal RRSPS; however, family law does not apply the same rules for division of assets of married couples and common-law partners, so consult your lawyer to have a better understanding.
Use this site as a guide to analyze your income tax:
AL RAMSAY is TD Bank Group’s regional manager, LGBTA Business Development, and leads a team of expert advisors dedicated to serving the LGBTA community. For more information or to book a meeting, he can be reached at firstname.lastname@example.org or follow him on Twitter at @AlRamsay_TD. ORLANDO LOPEZ, TD Wealth Financial Planner, is a member of Al’s team of expert advisors supporting the LGBT community.