In my last Tips To Maximize Your RRSP post, I revealed a way to increase the amount you can contribute to a RRSP investment for minimal financial cost. I also show you the proper way to invest in a RRSP so you can get maximum value.
For part 2, I want to show you a twist on the Preauthorized Checking (PAC) method of RRSP investing. Many investors have trouble coming up with a hump sum to invest so they use a PAC, which takes a set amount out of their bank accounts each month to buy investments. Financial planners love to sell PAC because it’s easy to explain. A PAC allows you to “pay yourself first” and since the money is taken out at paycheck time, it’s just like another deduction so you learn to live without it. For many people, this “forced saving” is the only way they can save any money.
Registered Retirement Saving Plans (401K or IRA) are great candidates for PAC investments. By taking a set amount out each month to invest in a RRSP, the investor is saving for his retirement with tax-free growth and he’ll get a RRSP receipt at the end of the year so he can get a tax refund.
There is nothing wrong with investing in a RRSP using a PAC. However, there is a better way of doing it. The problem with the PAC is you cannot get your RRSP receipt until the end of the year. By that time, you’ll qualify for a tax refund because of the monthly RRSP contributions. If you’ve read any of my older investment articles, you’ll know how I feel about getting a tax refund. How can you invest in a RRSP with a PAC and make it so you don’t get a tax refund?
Making The Bank Work For You
Let’s assume you are in the 40% tax bracket and you’re saving $500 each month to put into a RRSP. At the end of the year, you’ll get a RRSP receipt for $6,000, which will trigger a $2,400 tax refund ($6,000×40%). While it’s great you’re saving money for retirement, this is not the ideal PAC investment. Here’s how to do it correctly.
Go to your bank and borrow $9,500 to buy your 2007 RRSP. Take your RRSP receipt to the Canada Revenue Agency and get a letter from them that tell your employer to make source deductions based on your gross income less the amount of your RRSP contribution. That will give you an extra $316.67 per month ($9,500 x 40% divide by 12) in your paycheck.
The payment on the $9,500 RRSP loan at 5% is $813.27 per month. $500 will come from you, the reminder will come from the $316.67 extra money you’ll get in your paycheck.
With this trick, instead of putting $6,000 over a year into a RRSP, you put $9,500 at the start of the year for an extra year of tax-free growth and it didn’t cost you any extra money out of your pocket. Best of all, you’ll get no refund at tax time because you have all your money working for you. The formula to work out how much to borrow so your PAC and extra cash will equal the monthly RRSP loan payment is a bit complex. However, your bank will be able to work it out for you.
The above example only works if you haven’t maxed out your RRSP contribution limit and is based on today’s Prime lending rate minus 1%. If you cannot get a RRSP loan at Prime minus one, go to another bank.