Strategies to Maximize Your RSP
Contributing to your Retirement Savings Plan (RSP) and the resultant
tax savings is only the first step towards maximizing your RSP's growth.
This section will introduce you to strategies that can help maximize your
RSP:
Contributing to Your RSP Early
The vast majority of Canadians make their contributions at the end of
the tax year. By making your RSP contribution either at the beginning
of the year—early 2006 for the 2006 tax year, instead of early
2007—or by making regular monthly contributions, you will build
a significantly larger RSP. This is due to the additional years of
compound growth that result from making your contribution sooner
rather than later.
Spousal RSPs
One of the most effective methods of income splitting between spouses
is achieved by contributing to a spousal RSP. The objective of this
strategy is to provide both spouses with similar incomes and similar
income tax rates in retirement. Before setting up a spousal RSP, a
couple should estimate their expected retirement incomes. If one spouse
is likely to have a significantly lower retirement income, then spousal
RSP contributions should be considered.
When a spousal RSP contribution is made, the spouse making
the contribution will claim the contribution on their tax return, while
the contribution will be deposited in the other spouse’s RSP.
Borrowing to Make an RSP Contribution
While borrowing to invest outside your RSP may provide you with
a tax-deductible interest expense, borrowing to make an RSP contribution
will not. Deciding whether or not to borrow is complicated by the fact
that you can carry forward your unused contribution limit to a future
year when cash may be available. While carrying forward your contribution
will avoid borrowing costs, tax-deferred growth must be forfeited. In
general, if you expect to be able to repay an RSP loan within one year, this
strategy should prove advantageous. Use your tax savings from the
contribution to help repay your RSP loan.
Timing Your RSP Deduction
While it is advisable to make your RSP contribution each year, you
can choose to delay claiming the tax deduction until a future tax year.
If your income tends to fluctuate from year to year it may be beneficial
to defer the tax deduction to a future year when your income, and thus
your tax rate, will be significantly higher. While this strategy delays
the tax savings, your contribution is growing tax-deferred.
To illustrate the benefit of this strategy, let’s assume that
your current marginal tax rate is 25% but you expect your income will rise
next year, increasing your tax rate to 40%. If you made a $10,000
contribution this year and claimed the deduction, you will save $2,500 in
tax, while waiting until next year would yield a $4,000 tax savings.
Setting a Target
If you are like many Canadians, you strive to save as much as possible within your RSP each year. The question that must be asked is, "Will it be enough?" Before you can answer this question you must determine your desired retirement lifestyle. Determining this objective will allow you to set a savings target for your RSP. Setting this target is the only way you can gauge your progress and determine when enough is truly enough.
As a rule of thumb, for every $10,000 in before-tax retirement income,
you must accumulate $150,000 in RSP assets by the year of retirement.
This assumes that your life expectancy once retired is 25 years, that
your income increases at a rate of 3% per year to keep pace with
inflation and an 8% growth rate on your investments.
Take the next step…talk to an advisor.
For help determining whether you're on track with your RSP,
please contact an advisor. Or, ask
an advisor to contact you.
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