5 RRSP Myths
Posted by Gail | Filed under Retirement Planning
I hate writing about RRSPs during the “season.” While everyone is focused on getting their contribution in before the deadline — and FIs are throwing ads in every direction — it feels like overkill. Though, I must admit, this “season” seemed light on the RRSP messages relative to some others. Anyhoo, now that the deadline is past, it’s time to deal with RRSPs proactively… Let’s get those auto-deposits set up people… just $50 a month to start is fine… and get the habit of savings cast in concrete!
Myths abound, and with the RRSP just past its 50th birthday, there’s been a lot of time to build some funny stories, misconceptions and delusions. Here are the five I run across most often:
Myth #1: You Have to Claim Your RRSP Deduction Each Year. You don’t. While most people do take the deduction for their RRSP contribution from the get-go, there’s no rule that says you can’t hold off. In fact, holding off makes sense when you’ll end up getting more money back from the taxman by delaying your gratification. So if you’re just starting out and earning not-so-much, don’t bother claiming the deduction… save ‘em up until you’re in a higher tax bracket when you’ll get a bigger bang for your buck.
Life changes are another reason to pause and think… Think…THINK…Take the case of a woman who goes off on maternity leave in the middle of the year. Since her income is dramatically reduced for that year, her marginal tax rate will also be lower. Claiming the deduction for her RRSP would mean frittering away a perfectly good deduction on a low-income year. Better to hold the deduction for a year when her taxable income is back up. Then, even though her RRSP contribution limit would be less (based on the previous year’s earned income, which may have been smaller), giving her little room to maneuver when trying to minimize her taxes, her undeducted contribution from the previous year will come in very handy.
Whether you’re having a baby, taking a year off to get an MBA or planning a sabbatical, knowing you can delay claiming your deduction without losing it means you can plan to make those RRSP contributions work even harder in terms of the deduction you’ll eventually receive. They also eliminate the excuse, “What’s the point, I don’t pay that much tax now anyway.”
Myth #2: You have to be over 19 to contribute to an RRSP. This misunderstanding came about because people under the age of 19 aren’t allowed to make an over-contribution to their RRSPs. However, anyone in Canada who has earned income and has filed a tax return, regardless of age, has RRSP contribution room. That includes kids with a paper-route, those that baby-sit, and children who have promising modeling or television careers.
Even if there’s little point in a child claiming the RRSP deduction because she owes little or no tax, the benefits of contributing to an RRSP makes the exercise worthwhile. First there’s the magic of compounding return. One RRSP contribution of $500 (he’d need an income of about $2,800) at age 10 compounding at an average return of nine percent will grow to more than $57,000 by 65. If your child contributes that $500 every year until 19, he’ll have more than $400,000. That’s a good deal by anyone’s standards, right? The second benefit is that since a child’s RRSP tax deduction can be carried forward indefinitely, when she does start working full time, she’ll have deductions she can use to offset the tax on her income.
Myth #3: If you’re over 71 you’re out of the RRSP business. Under current legislation, once you turn 71 you can no longer make contributions to an RRSP. If you happen to still be generating earned income, too bad! You’re out of luck. Maybe not. If you’re turning 71 but will continue to have earned income, whether from rental property, a professional practice or business ownership, there’s a way to get a deduction in the year you turn 72, even if you’re not allowed to make an RRSP contribution. In early December of your last year of contribution, make an additional contribution based on your earned income for that year. Yes, that’s technically an over-contribution. And yes, if it’s over the $2,000 lifetime limit, you’ll start incurring the one-percent-per-month fee. But that’ll only happen until the calendar clicks over to the new year so that means only one month’s worth of penalty. Now, even though you’re not allowed to make a contribution, you can claim the deduction for the contribution that you made last year. This could also help reduce your exposure to the OAS clawback by reducing your taxable income. Just remember not to get greedy. Don’t reduce your income to such a low point that you bring the alternative minimum tax into effect.
Also keep in mind that contributions to a spousal RRSP are based on your partner’s age. So even if you are an old geezer, as long as your partner is under 71 you can contribute on his or her behalf and grab a deduction.
Myth #4: You can’t use your RRSP as collateral for a loan. Even FIs don’t understand this one! There are no rules that say RRSP assets can’t be pledged as collateral, although your RRSP provider will likely tell you there are. However, there are consequences. If you borrow against your RRSP, the fair market value of the RRSP assets pledged are included in your income for tax purposes at the end of that year. When the plan’s assets are no longer pledged, you may deduct the amount previously included in your income, minus any loss resulting from using the plan’s assets as collateral.
So why would a person do this? Well let’s say you suddenly find yourself without a job and need to take money out of your RRSP to keep body and soul together. Once you do, there’s no way to put that money back into the plan. Even if you found yourself out of the cash flow squeeze, what’s been withdrawn stays withdrawn and that’s that. If instead of making a cash withdrawal, you used the assets as collateral for a loan, the money would be treated as if it had been deregistered and included in your income at the end of the year. (Here’s one good reason to have a small plan separate from all your other RRSP assets!) So if your cash flow crunch abates in the interim and you repay the loan, you’d remove the collateral obligation. By dong so, your RRSP assets would once again be safely tucked away and you’ll have lost nothing.
Myth #5: It doesn’t matter when you make your spousal RRSP contribution. This may be so if you never intend to make a withdrawal from the plan, but on the off chance that you do, it matters a lot when the money goes in. The spousal RRSP withdrawal rules are based on “calendar” years. Make a contribution for 2009 by December 2009, and then no further contributions, and you’ll be able to withdraw money attributed only to the planholder as soon as January 2012. Make that contribution some time in the first 60 days of 2010 and you’ll have to wait until January 2013 — a whole year later — before withdrawals are taxed solely in the planholder’s hands.
March 11, 2009 at 8:32 am
Thanks for the clarification, Gail! At least two of these were beliefs I had–until now. I like that it was post RSP season so I could actually absorb what you are saying.
Thanks for all you do!
March 11, 2009 at 8:57 am
[Myth #1: You Have to Claim Your RRSP Deduction Each Year.]
Oh! That’s excellent!!! I wish I new this three years ago.
Thank you!
March 11, 2009 at 11:05 am
Myth #4 was an eye-opener! That is excellent advice for emergency credit if (heaven forbid) the floor falls out from under someone…. and further reason to make BIG FAT RRSP contributions when income is good!
March 11, 2009 at 1:28 pm
I would like to respectfully add one more RRSP related tip:
You can hold your own mortgage within your Self Directed RRSP.
There are some restrictions and some fees involved and it always seemed like a poor choice when Mutual Funds within RRSP’s were delivering 10-12% results. Right now, the 4.5% that I am paying myself for my mortgage is the best investment I have. (and the only invesment that did not drop 40%) Financial Advisors hate it because you are taking money out of the pool that they make fees on. It is worth exploring if you are in the position to use it (i.e. your RRSP is bigger than your mortgage)
March 11, 2009 at 2:06 pm
Steve: WHAAAAAAAT?????
Are you sure?
March 11, 2009 at 2:09 pm
ioana:
Beware of fees! Google “Gordon Pape rrsp mortgage”. I did not know either.
March 11, 2009 at 2:30 pm
I did this two years ago when I turned 40. It was a psychological thing: I had wanted to be mortgage free by 40 and this was as close as I could get.
It cost between $1000 and $1500 to set it up at first (includes lawyers fees) . At the time it was a criticized move because of the fees and the fact that I was giving up the returns on my normal RRSP investments. As I mentioned above, this turns out to be the only investment I have that did not drop by 40% in the last few months. (Very much worth $1500 in this case). The mortgage just came up for renewal, and the bank treated it like any other mortgage renewal. I locked in at 4.5% for 5 years. No fees this time. You have to really twist your financial advisor’s arm to get them to do it. Today, more than ever, this maneuver is worth looking into.
March 11, 2009 at 7:53 pm
Oi – I feel like I felt the first time I took grade 11 math. This one went a little over my head.
March 12, 2009 at 9:27 am
Well, this is more of a theoretical “REAAALLY”, because I’m locked myself (5.4%) until pretty much I run out of mortgage, in 5 years. _IF_ all goes well..
Next life, I will get variable rate.
March 16, 2009 at 8:20 pm
I have a comment about Myth #1: You don’t have to claim your RRSP deduction every year.
I am a woman who went on maternity leave in 2008 and while I earned less income than in other years, I still managed to max out my RRSP deduction for 2008, yet I am not getting a tax refund as I usually do. I owe about $1500. If I were to defer my 2008 RRSP deduction, I will pay MORE tax in 2008.
My husband found an online forum where other parents are going through the same situation. Most are having to pay around $2500 in taxes so I suppose I am lucky that I am paying less. My husband suggests that I could have my employer deduct additional taxes from my paycheque to cover the taxes I would owe from receiving Employment Insurance benefits while on maternity leave.
So now the question I am pondering now with my husband and my financial planner, do I want to pay more tax in 2008 in order to pay less tax in 2009? If only I could look into the future to see how I could get the most tax savings.
Decisions, decisions.
March 3, 2010 at 10:37 am
In regards to Myth #1. I have been trying to figure out how to go about this. Alas, I’m not finding what I am looking for on CRA website. I may have an unclaimed rrsp contribution. I am currently looking into it. However, if I do, how do I go about claiming it? On my current 2009 tax return or do I fill out an adjustment form for the particular year it was missed? Is there a cutoff year as to how many years I can go back? Any help would be most appreciated.
March 22, 2011 at 12:20 am
I don’t know how to fix my mess. We put $11,000 in RRSP this year. I thought it was better to show it as the higher-earning person making a spousal contribution to the lower income person who has no pension. I made a big mistake – I think we should have shown it as the lower income person contributing to their own, because now the higher wage earner (making the spousal contribution) has over contributed by about $8,000. Low wage earner still has over $111,000 contribution room.