By Canada Life | Jan. 25, 2023
John Yanchus, CPA, CA, TEP, Director, Tax and Estate Planning

With RRSP season here, now is a great time to explore different strategies for your clients’ contributions.

What is an RRSP?

A registered retirement savings plan (RRSP) is used to:

• Save for retirement
• Enhance retirement planning
• Split retirement income with a spouse
• Help decrease taxes payable each year 

RRSPs are a tax-deferred account your clients contribute to based on earned income – up to 2023’s yearly maximum of $30,780 (the maximum is 29, 210 for 2022). Earned income includes employment and self-employment earnings plus other income, minus employment expenses and business or rental losses from the previous year.

Contribution amounts are carried forward indefinitely if they're not used or deducted in any taxation year. A tax deduction becomes available in the year of the contribution. It can be used to offset taxes payable on your client’s personal income tax return in that year or any future year. Your clients can contribute into an RRSP any time during the year, including the first 60 days of the year following the tax year.

All investment growth and income earned within the RRSP accumulates tax-free. All tax is deferred until money is removed from the account, at which time the amount is fully taxable at the client’s marginal tax rate. This can be very powerful when their marginal tax rate is high in the years they make contributions and lower in the years when they withdraw the funds.

4 strategies to contribute to an RRSP

1. Lump-sum deposit strategy

This strategy is straightforward. It represents any after-tax money your clients wish to contribute into their RRSP. A tax deduction is available for the taxation year in which money was contributed into the RRSP.

Example:

2. Reinvestment strategy

This strategy is like the first one but it includes an additional contribution from the tax refund generated by the original RRSP contribution. Once the tax refund is received based on their lump-sum deposit, your client can contribute that amount into their RRSP account. This will also provide an additional tax deduction in the following year.

Example:

3. Catch-up loan strategy

Your client can borrow money for an RRSP loan or to catch up on available contribution room, which is on their notice of assessment. Your client may want to use the catch-up strategy if they’re in a particularly high-income earning year. They can use the tax refund to pay back the loan. Depending on the size of the loan this can take a few months or years.

Example:

4. Gross-up strategy

The gross-up strategy expands on the previous strategies. The client borrows an amount equal to the expected tax refund prior to the contribution and uses the actual tax refund to repay the loan. This strategy will require knowledge of the clients's desired contribution amount and their marginal tax rate, as well as the calculation of the expected refund to be generated by the RRSP contribution. It will also require an RRSP line of credit to be available to borrow the expected refund amount so the full amount can be contributed into the RRSP.

The following formula can be used to calculate the amount to borrow:

(RRSP contribution amount x marginal tax rate) / (1 - marginal tax rate) = gross-up amount to borrow

Example:

Considerations

There’s always a risk when using borrowed money to invest.

Interest charges should be minimal, as the loan is expected to be outstanding for only a few months at the most. The interest when borrowing to invest in an RRSP isn’t deductible. The client shouldn't spend the tax refund but use it to pay off the loan to avoid more interest charges.

Did your client make any RRSP contributions allocated (or repayments) to the Home Buyers’ Plan or the Lifelong Learning Plan? They’re considered separately from the four strategies. These repayment amounts are not considered RRSP contributions for the purposes of generating a tax refund. 

Summary

There are many ways to help your clients plan their RRSP contributions. New investors may feel more comfortable starting with a lump-sum contribution. More experienced investors may be more interested in the grossed-up strategy. Whether your clients are trying to maximize their RRSP contribution each year, make catch-up contributions or take advantage of excess RRSP contribution room, they have the power to determine their RRSP outcome.

This material is for information purposes only and should not be construed as providing legal or tax advice. Reasonable efforts have been made to ensure its accuracy, but errors and omissions are possible. Using borrowed money to finance the purchase of securities involves greater risk than a purchase using cash resources only. If you borrow money to purchase securities, your responsibility to repay the loan and pay interest as required by its terms remains the same even if the value of the securities purchased declines. Investors should only borrow money to make such an investment if they have the financial resources to assume the risk of the loss of their investment as well as the repayment of any such loan.

All comments related to taxation are general in nature and are based on current Canadian tax legislation and interpretations for Canadian residents, which is subject to change. For individual circumstances, consult with your legal or tax professional. This information is provided by The Canada Life Assurance Company and is current as of January 2023.

Canada Life and design, and Canada Life Investment Management and design are trademarks of The Canada Life Assurance Company.