10 things to think about this RRSP season

In preparation for this year’s RRSP tax season, the Invesco Tax and Estate Team shares 10 tax-savvy tips for investors to consider.

1. Harness the tax advantages of the RRSP

If you have yet to consider the importance of an RRSP, its primary advantage is the potential tax deferral and tax arbitrage. The deferral tax advantage of the RRSP is the power of tax-free compounding of investment income generated within a registered plan relative to a taxable non-registered account.

The taxable non-registered account incurs an annual (or periodic) tax drag since there is no opportunity for a tax deferral of investment income generated. This difference accumulates and compounds over time making the registered plan a better tax-advantaged option for investment.

 The tax arbitrage opportunity comes from the tax savings on deductions taken for contributions made in high marginal tax rate (MTR) years compared to the (hopefully) lower marginal tax rates in years when the RRSP proceeds are withdrawn —likely during retirement.

Know the limit, stay within it

The Canada Revenue Agency will calculate your RRSP deduction limit as follows:

Your unused deduction room at the end of the preceding year

PLUS

The lesser of:

• 18% of your earned income in the previous year; and
• The annual RRSP limit ($29,210 for 2022; $30,780 for 2023)

That exceeds one of the following items:

• Your pension adjustments (PA)
• A prescribed amount

PLUS

Your pension adjustment reversal (PAR)

MINUS

Your net past service pension adjustment (PSPA)

After you file your income tax and benefit return for 2022, the CRA will send you a notice of assessment (NOA) for the year. Your NOA will show the “RRSP deduction limit for 2023,” from which “Unused RRSP contributions previously reported and available to deduct for 2023” is subtracted to arrive at your available contribution room for the current year (i.e., 2023). If the contribution room is a negative number that is greater than $2000,¹ overcontribution penalty taxes may apply.

To access your NOA, please log in to your My Account via the CRA website.

2. Spousal RRSPs

A spousal RRSP builds on the RRSP arbitrage opportunity (high to low tax bracket) not only across time, but also across taxpayers — to a spouse expected to be at lower future tax bracket. But keep the spousal attribution rules in mind. A spousal RRSP withdrawal made in 2023 would be attributed back to the contributor spouse if a contribution was made into a spousal RRSP at any time in 2023, 2022, or 2021. The amount attributed back and taxed to the spousal contributor is limited to the amounts contributed within this time frame.

3. Pay down debt

If you are expecting a tax refund this tax season, consider using that refund to pay down debt.

Discretionary non-deductible debt

Discretionary non-deductible debt can often compound against us faster than we can accumulate savings; eliminate such costly commitments as soon as manageable.

RRSP loans

An RRSP loan allows an individual to borrow money to contribute to their RRSP. While an RRSP loan can help get money into an RRSP and lower an individual’s taxable income through a tax refund, it can also put a strain on future years’ living expenses and savings if the loan is not paid off in the current year. As well, the loan interest is non-deductible.

Mortgage reduction

Importantly, a mortgage funds current and future housing, but principal and interest are non-deductible if the house is for personal use. Paying down a mortgage allows for more of a monthly budget to be devoted to retirement savings.

4. Tax-free savings account (TFSA)

For low tax bracket individuals, it makes more ‘tax sense’ to contribute into a TFSA as opposed to an RRSP. Deciding on which registered plan is right for you may largely depend on your current MTR versus your expected future MTR upon withdrawal. Often, both an RRSP and a TFSA will be used throughout one’s life and career with one taking precedence over the other by employing a tactical and strategic long-term wealth plan. The goal is to work towards maximizing the ability to realize absolute tax savings through coordination between the RRSP and TFSA throughout your career/life.

As a recap, the TFSA allows tax-free growth and tax-free withdrawals and is funded out of after-tax dollars. The annual allotment of TFSA room for 2023 is $6,500. For reference, the total accumulated allocated TFSA room from 2009 through to 2023 is $88,000. For a quick reference of the tax neutrality of the TFSA versus RRSP, see the example in the chart below.

5. Registered educations savings plan (RESP)

An RESP boosts education savings through income splitting, tax sheltering, and government grants of up to 20% federally on the first $2,500 of contributions, with some provinces offering further financial support through additional bonds and grants (some do not require actual contributions). An expected refund can be redirected into a RESP to maximize grants. And in some cases, as opposed to making an RRSP contribution, money can instead be directed into an RESP to fund your child/grandchild’s education costs.

Recall also that an Accumulated Income Payment (AIP)² may be contributed to an RRSP without the punitive additional penalty tax of 20% that would otherwise apply on an AIP withdrawal. The limit is $50,000 per subscriber ($100,000 for joint spousal RESP plans) but is subject to available RRSP room.

6. Registered disability savings plan (RDSP)

Families with disability issues can face large financial challenges. The RDSP enables income splitting, tax sheltering, free government bonds, and up to 300% in matching grants. For deaths occurring after March 3, 2010, the RDSP rules permit a rollover of a deceased individual’s RRSP proceeds to an RDSP belonging to a financially dependent child or grandchild by reasons of a mental or physical infirmity.

7. First home savings accounts (FHSA)

Introduced in Budget 2022, the tax-free first home savings account (FHSA) officially launches on April 1, 2023. The FHSA is designed to help first-time homebuyers save for the purchase of a home. To do so, it will combine elements of TFSAs and RRSPs to create a uniquely tax-advantaged savings environment. Contributions made to FHSAs will be tax deductible, investment income and growth inside the plan will accumulate tax free, and qualifying withdrawals made to purchase a first home will be non-taxable.

The rules (were modified to) now permit an individual to utilize both the Home Buyers’ Plan (HBP) and the FHSA for the same qualifying home purchase. In addition, funds may be transferred directly from an FHSA to an RRSP or a RRIF on a tax-free basis without affecting the individual’s available RRSP contribution room. Funds may also be transferred from an RRSP or a RRIF to an FHSA on a tax-free basis, subject to the FHSA’s lifetime and annual contribution limits.

Financial institutions are working diligently to ensure they are ready in time for the April launch.

8. Non-registered investments

Registered savings form the core of retirement savings. Projected spending patterns may show a need to supplement that with non-registered investments. Investing a refund can get that part of a plan underway.

9. Final spousal RRSP contributions after death

While no contributions can be made to a deceased individual’s RRSP after death, there is an opportunity for the legal representative of the deceased to contribute to a spousal RRSP in the year of death or within the first 60 days following the year of death. Any spousal RRSP contributions can be used as a deduction on the deceased’s final income tax return.

10. Spend some, but not too much

A tax refund can feel like ‘found money’ though in reality it’s an overpayment of tax that the government eventually gives back to you at a zero rate of return. For most of us, it’s the result of taxes withheld during the year based on assumed annual income. The full picture only becomes clear while you are filing your tax return (using the RRSP maximizer function that many online tax software services offer) or once your tax return is filed and all credits and deductions are fully accounted for. Whether that refund was planned or a surprise, consider spending some of that refund on things that make you happy.