Tips To Maximize Your RRSP – Part 2

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.


27 thoughts on “Tips To Maximize Your RRSP – Part 2”

  1. Jeff says:

    As for me, I was always behind with my RRSPs, so I often took out a RSP catch up line of credit.

    Considering that those LOCs come at prime rate, and the immediate tax refund is higher AND I get the growth of nearly 20% a year (which I’ve averaged over the last 2 years) it’s a pretty good deal I’d say.

    Of course, if you can get ahead with the PAC earlier, it’s better cause you pay less interest and you get a lot MORE extra accumulation of interest.

    1. Jeff says:

      For 2006 though, I’m not contributing at all. It was my first year starting my business, and i had a LOT of write-offs, so my tax bracket is lower. I may as well use up the contribution room this year, cause I’m positive I will make more money this year.

  2. bryce says:

    Canadian/United States of American finance seems confusing.

    1. Marc says:

      It doesn’t have to be, but if you’re going to try to maximize your money and minimize what you pay in taxes, it certainly can get very complicated.

    2. Kalle says:

      I have to agree with that 🙂

    3. June Walker says:

      It’s not so much that taxes and finance are complex and confusing, it’s that the folks talking and writing about the topic aren’t adept at clear and simple explanations. Take a look at two places for easy-to-undersatnd tax and finance info for self-employeds:
      http://junewalkeronline.com and http://www.junewalkeronline.blogspot.com.

  3. Soultrance says:

    I don’t understand how doing what you suggest gives you the ability to max out your RRSP’s at the start of the year with no additional cost.

    “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.”

    Would that mean I’d have to be paying out $500 of my own money, every month, to cover the cost of RRSP loan? Or am I missing something here.

    I will admit, my math skills are terrible and my knowledge of this stuff is limited, which is why I really appreciate the tips you’re giving, as I’d really like to learn more about this stuff.

    1. John Chow says:

      The post assume you were already saving $500 per month into a PAC for RRSP investment. Instead of doing that, you borrow enough from the bank so that you are still paying $500 per month. However, you are able to contribute a lot more because of the extra $316 you get each month.

      Nothing has changed. You still save $500 per month but instead of building up $6,000 or RRSP, you build up $9,500.

      1. Soultrance says:

        I understand now.

        Thanks a lot John.

  4. Michael Kwan says:

    Good post John. As a freelance writer, though, I don’t have to worry about deductions because I have to pay one lump sum at the end of the year anyways. I’ll never get an income tax refund ever again 🙂

  5. John Chow says:

    If you have to pay more than $1,000 in taxes, CRA will eventually send you a letter saying they want installments. It may take them a few years but they’ll get around to it. 🙂

    1. Marc says:

      That’s a very interesting tidbit of information. Thanks for sharing John.

  6. Good tip John. I have received a tax deduction another way though and I use a PAC. I just happened to write about this yesterday on my blog too.

    For the past 3 years I have filled out a T1213 for (Request to Reduce Tax Deductions at Source). This is a Canadian Revenue Agency form. You can get it at http://www.cra-arc.gc.ca/E/pbg/tf/t1213/t1213-04b-e.pdf.

    All you need to do is fill it out, attach a sticky note or piece of paper showing your PAC information and RRSP room. I show the following info:

    1. My annual gross salary.
    2. My RRSP contribution room. In Canada, this will be 18% of your salary in the previous year (up to a max of $18,000 I believe) added to whatever room you still have left. So I would just take what I made last year and times it be 0.18. This will be my new room this year (approximately).
    3. Your current monthly contributions (PAC plan).
    4. What you will have contributed during the year. This is the monthly contributions multiplied by 12 plus whatever lump sums of money you have put in there as well so far (you will have only had a month or so to do this so it is probably 0).
    5. The RRSP account number
    6. The brokerage, broker’s name, and contact information.

    I send it to my federal tax office (addresses are online) and they send me back a letter authorizing my employer to reduce my taxes on each pay stub.

    You have to reapply every year because your RRSP room changes.

  7. ejunky says:

    John,
    I noticed this interesting article that mentions your blogs and “Tax deduction benefits”. Do you take advantage of this?
    http://crimesift.com/2007/02/09/john-chow-and-the-tax-benefits-of-blogging/

  8. Indi Scoop says:

    this is just a number game…

    how come both are equal…. in first scheme you get 2400 tax return, so the only advantage of second scheme is you dont give the govt money with out interest just to get it back as tax refund… i wonder why some readers are saying “good point john.. thanks”

    you wrote as if by following second scheme one can save 3500 additional dollars… thats not true. you are in fact additionally paying the money you would other wise get back as refund

    1. Indi Scoop says:

      but thanks to you… today i confirmed one point which i was in doubt. there are enough online people who are having very limited skills…. implying that you get traffic even if you write trivial stuff

    2. John Chow says:

      Why in the world would you want to get a refund? Do you enjoy lending YOUR MONEY to the government INTEREST FREE?

      Think about for a bit.

      1. Indi Scoop says:

        You did not get my point. You calimed

        >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.

        it costs me extra money. the additional 3500$ is not all free. i would get that only if i pay the 361$ i save every month from tax. do you see it now?

        1. John Chow says:

          Well, what else are you going to do with the saving? Spend it? I guess you could do that but then you wouldn’t be able to pay back your loan. 🙂

          The point of these trick is to not get a tax refund because getting a tax refund is the stupidest thing you can do. Why give your money to the government to use when it can be working for you?

          1. Mark says:

            I kind of agree with Indi Scoop.

            I understand that you are telling people to buy RRSP at the start of the year and take the tax refund fist without waiting for the year end. The benefit is the extra earnings from being able to invest $9500 at the beginning of the year instead of investing $500 each month and then invest the tax refund to make up to 9500 at the year end.

            However, with your trick, interest 259.24 needs to be paid. Which also means that we are losing 259.24 from what we would have earned from RRSP investment. You should have mentioned that.

            Let’s look at ordinary scheme again and make some adjustments. Let’s say we will invest $6000 throughout the year. Tax refund we would get is 2400. Assuming we would borrow $3500 and buy RRSP in February of next year, our RRSP would become $9500. What would be tax refund? $3800. You can pay back $3500 you have borrowed. You would even end up having extra money after deducting interest. If we have to borrow it for 2 months, interest is $30 and we have $270 in our pocket.

            Yes, there may be difference in the balance in the RRSP account even though $9500 was invested in both ways. If that difference would be more than $270, your way is better. Otherwise, it won’t give that much advantages.

            However, with Group RRSP plans, we can earn the tax refund back on every paycheck based on the monthly RRSP contributions. With $500 contribution every month, $200 refund would be on the paycheck. I am already enjoying that. Yes, not everyone may have that chance. People in such situation can already contribute $791.66 very month and will end up making $9500 contribution. Paycheck in each month will see $316.66 increase. So, it’s only $475 contribution every month. You got $25 every month to spend on something or even put it back into RRSP and end up more than $9500 contribution. The earnings will also be increased since more money is invested earlier. Extra $300 a year is already around 3% return for $9500.

            So what I want to point out is that your suggestion is not “very good”. It has it’s own expenses and everyone should be aware of it.

            Anyway, appreciate your efforts posting such blogs and let people think more….

          2. Indi Scoop says:

            you are not at all seeing my point. you are giving a false illusion that by following the loan mechanism one could raise additional 3500$ freely. thats wrong. its all your money in some or other form. nothing is free.

            even now if you cant see the point, only IMing will help. my gmail address is given above. if you have time ping me.

            (and i totally know why getting a tax refund is stupid. for the record, in my seven years of career i never got a rax refund)

            and now i slowly see why people call you EVIL… 🙂

          3. Indi Scoop says:

            by the way the message “(Comments wont nest below this level)” does not make sense. you can see it why

          4. Indi Scoop says:

            hey just now i realised, i think if i continue discussing here i can get a link back as a top commentor 🙂 ok no more spam from me,

  9. Mark says:

    There are omissions in that article.

    There’s interest 259.24 paid to bank for $9500 loan. That amount is paid out of what would be earned from $9500 investment.

    For original plan, let’s add some more actions about it……
    – $6000 is invested over 12 months
    – $2400 is received at the end of the month for $6000
    – If our target is to have $9500 at the year end, we need to borrow $3500 from bank at the end of year and invest it.
    – Now, tax refund would be $3800 instead of $2400.
    – You pay back $3500 to bank plus $30 if you borrow money for 2 months
    – So, you have $270 extra cash, and $9500 RRSP contribution

    Another alternative…using Group RRSP plans
    – Invest 791.66 every month in RRSP which will end up $9500 in RRSP contribution
    – With Group RRSP plan, tax won’t be deducted for RRSP contribution amount which is 316.66
    – So every month, you are investing 475 (791.66 – 316.66) net out of your paycheck.
    – Compared with original plan to invest $500 every month, you have extra $25 every month
    – You can have $300 or more (if you put it in some saving account) to spend on anything at the end of the year.
    – You still have $9500 in RRSP contribution.

    So, the difference would be the return from $9500 contribution and the end balance in your RRSP account. Following should be compared.
    (a) Resulting balance from investing $9500 at the beginning of the year
    (b) Resulting balance from investing $500 every month and $3500 at the end of the year plus $270 cash in your hand
    (c) Resulting balance from investing $791.66 every month plus $300 cash in your hand

    So, it really depends what is the return rate of the investment.

  10. Nomar says:

    I am reading up with this one, but it is not for me 🙂 though it is interesting

  11. David says:

    For the 2006 tax year I was forced to dip into one of my RRSP’s. My average tax rate was 33.9% and marginal was around 44%.

    I do not have any additional funds this year to counter balance this large tax payment. Both my wife and myself have additional RRSP contribution room. Is there any stragegy I can use to reduce is tax burden?

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