Those who’ve read my article called Why I Will No Longer Contribute To My RRSP may raise an eyebrow at this article’s title. 😉
Please be aware that my RRSP game plan does not apply to everyone. For most people, maximizing their RRSP is a great idea.
So I wanted to share this tip to help optimize RRSP contributions for those who still have unused contributions.
Although I really don’t encourage going into debt, this method could require the use of an RRSP loan, a personal loan, a line of credit or any other form of borrowing. When done properly, it is possible to pay little or no interest while boosting your RRSP contributions.
So, if you contributed to your RRSP this year without reaching your maximum contribution, this article will probably be useful. 🙂
RRSP Season
That’s what many financial institutions like to call the first 60 days of the year. In fact, it is the last sprint to contribute to your RRSP to reduce taxes for the previous year.
Generally speaking, some people neglect their RRSPs all year round. Once RRSP season knocks at their door, these people rush to put money into their RRSP (sometimes with the help of a loan), to ensure they get a tax refund (in order to pay for the next trip down south).
Reminds you of someone you know? 😉
A much sounder way to save is to do it automatically and regularly throughout the year. This is an excellent financial habit to take to ensure a good retirement (early or not).
What’s more, once you’ve saved throughout the year, you’re in an excellent position to boost your contributions thanks to the RRSP loan, for example, which your financial institution may even have already offered you.
The Classic Method
I usually like to show you examples using my own numbers. However, as of today, my RRSP is already fully maxed out. I will therefore take my sister’s example to show you the classic method used to contribute to an RRSP.
In 2020, my sister contributed $11,780 to her RRSP. This will be used to reduce her taxes for the same year. Congratulations! I wonder who she takes after. 🙂 However, for the sake of a better understanding, I will round it up to $10,000.
She has about $12,000 left in unused contributions. So she could continue to contribute without any problem. However, she has decided to focus her savings in her TFSA, for now.
Using Wealthsimple’s calculator, I can get the details about her marginal tax rate and her estimated tax refund.
She can therefore expect a tax refund of approximately $3,270. Wonderful!
This is where good savers are already planning to reinvest this refund directly into their RRSPs to reduce their 2021 taxes. That’s exactly what my sister was planning to do.
This is where I came in. Because by using the RRSP loan, or any other form of borrowing, there is a way to boost RRSP contributions for the year 2020 without really paying more out of pocket.
The Optimized Method
If my sister got a loan for the same amount as the expected tax refund ($3,270), and contributed that amount within the first 60 days of 2021, she would then increase her total contributions to $13,270 in order to reduce her 2020 taxes.
As a result, her tax refund will no longer be $3,720. It will increase to $4,171.
With this amount, she’d have plenty of money to quickly repay the loan in full and avoid paying interest. There would even be enough left over to contribute to the RRSP again in order to reduce her 2021 taxes.
However, if you understood the method, you may see where I’m going with this.
If my sister can now expect to receive $4,171, then why not borrow that amount instead and add it into the RRSP within the first 60 days of 2021?
Her total contribution to reduce her 2020 taxes would then be $14,171, which would then generate a tax refund of $4,419.
You can keep going until you reach the point of intersection.
Ideally, one does not want to borrow more than the expected tax refunds, since it will be used to repay the loan. This way, you avoid paying interests. Of course, some RRSP loans have such low interest rates that it could still be interesting to borrow a little more and accept to pay some very minimal interests.
Ultimately, it’s up to you to decide how comfortable you are with borrowing to invest.
The Point of Intersection
In my sister’s example, the sweet spot is about $4,512 that she’d need to borrow.
Indeed, that means she’d contribute a total of $14,512 in her RRSP and get $4,512 in tax refunds. This refund would then be equal to the amount borrowed.
It could be simpler for you to use this calculator to find out the total contribution you would have to make. Simply enter the amount you have already contributed to date and your tax rate.
Upon receipt of the tax refund, my sister will repay the loan in full. She’d then be able to start fresh with regular (automated) RRSP contributions for 2021.
Finally, instead of a non-optimized tax refund of $3,700 to reduce her 2021 taxes, she will have added $4,512 to her contributions to reduce her 2020 taxes.
By doing so, she advances future contributions to her RRSP. If she keeps doing that every year, she’ll max out her RRSP in no time and reap off the benefits of compound interest a bit earlier. 😉
A Debt That’s Worth Its Weight in Gold
Of course, the idea is to advance future contributions. It doesn’t necessarily have to be through an RRSP loan. The money can come from a line of credit or a loan from a friend, for example. You can be creative.
Personally, when I still had unused contributions, I borrowed the money from myself, or more specifically from my emergency fund. I had a zero-dollar emergency fund for a couple of weeks or months, but I was willing to take the risk. It also allowed me to pay no interest on a loan, besides the opportunity cost of the interest (1-2%) the money in my emergency fund would have generated.
If you are able to find interest-free money, it may be interesting to borrow more than the expected tax refunds. That’s entirely up to you. 🙂
In addition, for those who contribute to labour-sponsored funds such as FTQ or Fondaction, 30% or 35% tax credits increase tax refunds considerably and make the method even more efficient!
That’s precisely what I did back in 2018 and 2019, when I had not yet maxed out my RRSP. It really increased my savings and helped max out my RRSP sooner!
Keep in mind that you need to have the discipline to use the tax refund to pay off the loan in full, rather than using it to pay for an all-inclusive vacation. 😉
Bonus
Of course, anyone who optimizes their RRSP contributions will see their taxable income decrease. This could have the effect of giving access to or increasing GST and solidarity (or other provincial) tax credit refunds.
This is also a very interesting for families. By reducing their taxable income even further, parents who make use of this method will be able to increase their child benefits.
If these refunds and benefits are then added to the RRSP throughout the year, this will set the stage for the next RRSP season. At least, until the RRSP is maxed out. 🙂
Yes, More Tax Optimization
I’m really that boring. However, anyone who is able to use the method described in this article will benefit from it. 🙂
I’m curious to know if you have tricks like that to optimize your registered accounts or your taxes in general. Do you have any tips on how to make the most of RRSP season? Feel free to leave a comment!
In the meantime, I’m looking forward to my favourite season. I’m talking, of course… about tax season. 😉
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January 23, 2021 at 2:49 pm
This is a good idea if you are disciplined enough to not spend the tax return.
You could also decrease your taxes at the source throughout the year (by filling in a T1213). If you are making regular RRSP contributions this helps you keep more money in your pocket throughout the year.
January 24, 2021 at 1:30 pm
Yes, that’s a good idea too! Though, so few people know about it that sometimes, even HR don’t know what to do with it. 😂 I used the form for 2020 and according to my calculations, I’ll still get a considerable tax refunds. Oh well, I’ll take it!