February 1, 2008, 7:48 am

Some RRSP basic strategies

by: The Financial Blogger    Category: RRSP
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We are now February 1st and you have only a month left to contribute to your RRSP. But simply putting money aside in a RRSP account will only do so much. In fact, there are some basic strategies that could make your retirement portfolio much bigger. These strategies can be applied by anybody without much financial background of heavy calculation.


Reinvest your tax return into your RRSP

Many people do it already but I wanted to point the power of compound interest of this strategy. Let’s say that you make 75K a year and you are taxed at 40%. If you make a contribution of 5K per year for the next 25 years, your portfolio would worth $394,772 with an 8% return.


Over this period of time, you will receive $2,000 in tax return every year. If you invest this amount of money over 24 years (you get your tax return only after the 1st year of contribution). This would equal to another $144,211 in your portfolio for a total of $538,983 in today’s dollar.


In addition to that, you will also receive an addition tax return on that extra 2K contribution you are making after the first year. This tax return equal $800. You can invest this amount as well in your RRSP over the next 23 years in order to get an additional $52,611. at this point, your $125,000 overall contribution (5K * 25 years) would give you $591,595. So by investing your tax return from your RRSP contributions, you will get $196,823 more in your portfolio.


If you want to make the exact calculation I suggest you go on the Ernst & Young Tax Calculator to get your marginal tax rate. Then, you can use any investment calculators from bank’s website or even better, bring your numbers to your banker and make him do the math!


Take a deferred payment RRSP loan

We will keep the same numbers from our previous example in order to demonstrate the power of taking a deferred payment RRSP loan. In financial planning, they say that RRSP loans are good as long as you are able to pay them off within two years. An interesting technique is to calculate your tax return according to your RRSP contribution and to make a loan in that amount.


In order to not affect your cash flow, you can take a RRSP loan in January of 2K and defer your first payment in six months. Therefore, you will not have to make your first payment before you get your tax return. In addition to that, your tax return will be of $2,800 instead of $2000 because your overall contribution for the first year will be 7K compared to 5K without the RRSP loan.


In our calculation, this accelerates the additional investment by 1 year in term of contribution. Therefore, you would get a total of $610,365 in your RRSP account after 25 years. However, you would have to pay interest on your 6 months RRSP loan where you don’t make any payment until you get your tax return. At a 7% interest rate on 2K over 6 months, this represents $70 per year or $1,750 for the full 25 years. However, you find yourself richer of $17,020!


You can easily get your tax refund from Ernst & Young’s website or then again, make your banker does some maths to make you richer. After all, it’s his job!


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That’s a good trick, but it’s all about finding how much you can afford to contribute. I pay all my taxes at the end of the year so instead of waiting for a refund I can make bigger contributions during the year and get the same advantage. I’m not sure how a loan would factor in… investment returns should be greater than 7%, but getting an advantage of a few percent for a few months on a small amount doesn’t seem like much. It’s probably better to earn the money, then contribute it plus the interest that I would have paid on a loan.

Great post! I have a post written about RRSP loans as well that will be posted next week.

Better yet, if you file form T1213 you can have less money reduced from your pay cheque and use that savings to contribute more to your RRSP upfront. Even more compouning (and less loans to the government)!

On point about RRSPs, which I learned firsthand by taking a loan to max out the RRSP. I would recommend AGAINST it if your income will go up in the future. If you are still young, especially if you live in an oppresive tax regime like The Financial Blogger and I do, then you should avoid making your RRSP contributions until you are in the top tax bracket.

Reason is this: As long as you don’t buy and sell then your outside-of-RRSP assets grow tax free anyway. As well, if you take a loan then your interest for the purpose of investments is tax deductible and so usually at least 30% lower. It’s not brain surgery that you should take a loan to invest, even outside the RRSP (Correct me if I’m wrong but the Smith Manouvre is a form of this). So, make the investments but don’t contribute to RRSP if your income will get much larger within a few years.

Then, when your income is in the highest bracket you contribute to the RRSP. You will have a lot of room because you didn’t use it before, so slam the money in until your taxable income just touches the top of next lower bracket and claim your huge tax refund. Do the same until all your room is used up.

Do the math for your specific situation but if, for example you are in an entry level professional position or recently out of school, or like the Financial Blogger, going to MBA school expecting to multiply his income soom, then it’s probably worth it to wait a couple of years and build up the room. Important to still invest, however, just not in the RRSP.

by: The Financial Blogger | February 4th, 2008 (10:59 pm)

I would add that if you are not too comfortable with leveraging strategies, you can still contribute to your RRSP but claim the tax deduction later on when you are making more money as mentioned in the previous comment. It is another great way to maximize your tax return!

How do you claim your tax deduction against future income in another tax bracket? When you contribute to an RRSP don’t you just get an RRSP slip that year to be used against that year’s income (or for contributions in Jan/Feb you can choose which year)?

by: The Financial Blogger | February 7th, 2008 (7:40 am)

When you fill in your tax report you can choose to not declare the whole amount and report it in a future year. However, it is up to you to keep track of what you contributed and what you declared as RRSP. Therefore, you would get the tax deduction according to the amount deposited in your RRSP account and can claim the difference later on 🙂

[…] The Financial Blogger writes about some RRSP strategies.  What I learned from the article was that you can get deferred payment RRSP loans.  This means that you can get an RRSP loan earlier in the year and pay it back when you get your tax return.  I will post my thoughts on RRSP loans next week. […]

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