RRSP strategies

Strategies to maximize your RRSP

Contributing to your Retirement Savings Plan (RRSP) and the resultant tax savings is only the first step towards maximizing your RRSP's growth. This section will introduce you to strategies that can help maximize your RRSP:

Contributing to your RRSP early

The vast majority of Canadians make their contributions at the end of the tax year. By making your RRSP 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 RRSP. This is due to the additional years of compound growth that result from making your contribution sooner rather than later.

Spousal RRSPs

One of the most effective methods of income splitting between spouses is achieved by contributing to a spousal RRSP. 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 RRSP, a couple should estimate their expected retirement incomes. If one spouse is likely to have a significantly lower retirement income, then spousal RRSP contributions should be considered.

When a spousal RRSP 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 RRSP.

Borrowing to make an RRSP contribution

While borrowing to invest outside your RRSP may provide you with a tax-deductible interest expense, borrowing to make an RRSP 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 RRSP loan within one year, this strategy should prove advantageous. Use your tax savings from the contribution to help repay your RRSP loan.

Timing your RRSP deduction

While it is advisable to make your RRSP 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.

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