Tips To Maximize Your RRSP

Income tax time is here again and that means every financial planner and his dog are trying to sell you some RRSP (401K or IRA in the US) to help reduced your income tax bill. Why people wait till the start of 2007 to buy a RRSP for 2006 is really beyond me but if you are in this group, here is a trick you can do to get the most out of your Registered Retirement Savings Plan (RRSP) contribution.

Putting The Refund To Work

When you buy a RRSP, you trigger a tax refund equal to the marginal tax percentage of your contribution. For example, if you were in the 40% tax bracket, a $10,000 RRSP contribution will give you a $4,000 tax refund. If you were in the 50% tax bracket, you’ll get $5,000 back. Most people spend their tax refunds on butter when what they should be doing is putting that refund back into the RRSP. How do you do that?

Before I show you the steps, I have to say this will only work for someone who has not maximized their RRSP contribution to the limit ($18,000 or 18% of 2006 income, whichever is less). The majority of Canadian (and I suspect Americans as well) do not maximize their registered retirement savings accounts because they do not have the needed funds. Here is a way to get a lot more money into your RRSP at almost zero cost.

Let’s assume you are in the 40% tax bracket and have $10,000 to invest into a RRSP. What you do is go to your bank and make a RRSP loan for $6,666.67, add in your $10,000 and buy $16,666.67 of RRSP investments. This will trigger a tax refund of $6,666.67 ($16,666.67 X 40%) which you will use to pay back the bank. Your cost will be 1 to 2 months of interest at most (interest on RRSP loans are not tax deductible). This kind of loan is extremely safe for the banks (they know they’ll be paid back with the tax refund) and they will give it to you below Prime.

With the above strategy, you no longer have a tax refund (well, you do but it’s going to the bank) but you increased the funds you put into your RRSP by a huge amount. This will make an amazing different at retirement time. $10,000 a year into a RRSP at 8% for 20 years will turn into $494,229.21. However, $16,666.67 invested at 8% for 20 years will turn into $823,715.52.

The formula on how much you can borrow so the tax refund matches the RRSP loan is:

Amount available to invest divided by 1 minus your marginal tax rate.
In the above example, it’s $10,000/(1-0.4)=$16,666.67

Many people take their RRSP tax refund and use it to help pay down their mortgage. However, I advise doing that only after you’ve maximized your RRSP contribution. If the above investor were to put $10K into his RRSP he would receive a $4,000 refund to use against his mortgage. That gives him a total investment of $14,000 vs. $16,666.67. More money working for you is always better. On the other hand, if the investor already has enough to maximize his RRSP, then the refund should definitely go to paying down a mortgage.

The Proper Way To Invest In a RRSP

Most people buy their RRSP around this time of the year because it’s tax time. Financial planners and banks sell the RRSP as a way to reduce taxable income and get a tax refund. When your work place deducts taxes from your paycheck, they do so based on the assumption that you will not be buying any RRSP investments – this is why you get a tax refund. If your employer deducts from you paycheck based on you buying a RRSP, they would not withhold as much – that gives more money in your pocket from each paycheck. How can you make your employer do this? By buying your 2007 RRSP now instead of in 2008.

Some people may not know this, but RRSP investments are available for purchase anytime of the year. You don’t have to wait till tax time to buy it. Say you buy $10,000 of 2007 RRSP at the start of year and you’re in the 40% tax bracket. That will trigger a $4,000 tax refund when you file your 2007 tax return in 2008. However, you can take this RRSP receipt to the Canada Revenue Agency and get a letter from them that tells your employer to make source deductions based on your gross income less the amount of your RRSP contribution. This will give you about $334 extra per month ($4,000 divide by 12). When tax time comes in 2008, you will have no refund and you will get an extra year of tax-free RRSP growth because you brought the RRSP in the beginning of 2007 instead of 2008.

Getting a tax refund means YOU OVERPAID YOUR TAXES! It is the stupidest thing you can do! If you get a tax refund, it means you loan YOUR MONEY to the government for a whole year INTEREST FREE! The amazing thing is, most people are happy to get a tax refund! When someone tells me they’re getting XXXX amount back in a tax refund, I say, “I’m sorry to hear that.”

If you just brought your 2006 RRSP and don’t have any money to buy your 2007 RRSP, then borrow the money from your bank to buy it. Take the RRSP receipt to get the Canada Revenue Agency letter and use the extra money you get from each paycheck to help pay back the loan. This is how you make the system work for you, instead of against you.


34 thoughts on “Tips To Maximize Your RRSP”

  1. Andrew Kuo says:

    I definitely don’t have to worry about that right now. In college 😀 Looks like I’m gunna have to learn sooner or later :-/

    1. Nomar says:

      me to hehe 🙂

  2. Jeff says:

    Damn it John, I was going to do a post on this.. but you beat me to it..

    Oh well I’ll do it later in the month. 🙁

  3. Jeff says:

    You guys should ALL read the book by Suze Orman called “The Money Book for the Young Fabulous and Broke”. It explains your theory (hence my theory cause I agree with Suze and you) on not letting the government withhold the tax, but instead using it earlier to maximize the results.

    I have BMO Dividend Funds. Actually I’ve had them for 2 years now. Each year I see nearly a 20% growth in that fund.

    I also bought, this year, BMO Precious Metals Funds.

    Damn, BMO should pay me for this marketing of their Mutual Funds!!!

    Another note – this is an RSP, which is long term for most of us. NEVER put it in a conservative fund.

    BMO classifies funds into 4 categories based on the risk and the returns, and 4 is the highest.

    I have most of my money in the class 3 and some in class 4. NOTHING in class 2 or 1 anymore.. no point.

    Be bold.

  4. bryan says:

    I come from http://www.marketingschool.org

    I always visit your blog, I like it:)

    Cheers,
    Bryan

  5. Michael Kwan says:

    Where would you recommend we invest our RRSP money? This will be the first year that I’m seriously considering some “real” investment and not just the nice-and-safe GIC and/or high interest savings account (I currently hold most of my money at ING for 3.5%, but I know I can do better).

    1. Jeff says:

      As I mentioned,

      I have it in BMO mutual funds. BMO Dividend Funds have yielded great results.

      I’m also trying the precious metals funds this year (also from BMO) as the precious metals sector in Canada is getting better and better, especially that of BC’s.

      Don’t bother going with other more private Mutual Fund investors such as Edward Jones and such – they don’t necessarily give you a higher result, but they charge more management fees for hte novelty anyways.

  6. Soultrance says:

    Great, I’ve been waiting for this post ever since I emailed you to harass you about RRSP related stuff a few weeks ago. 🙂

    Thanks again for the info, and thanks to Jeff for the book recommendation, I’m going to have to look into that one.

    I’ve generally be horrible with my finances but finally have a decent paying job and have had RRSP contributions auto deducted from my check for just over a year, and I’m hoping to learn a whole lot more about investing and making my money work for me, as opposed to the other way around.

    Thanks again John.

  7. Soultrance says:

    Oh yeah, I forgot to ask, at what dollar figures do the different tax %’s take effect? I’m not sure which one I fall into as I think I may be right on the cusp.

    Thanks!

    1. John Chow says:

      15.25% on the first $36,378 of taxable income, plus
      22% on the next $36,378 of taxable income (on the portion of taxable income between $36,378 and $72,756), plus
      26% on the next $45,529 of taxable income (on the portion of taxable income between $72,756 and $118,285), plus
      29% of taxable income over $118,285.

      On top of the Fed tax, you have to add the Provincial tax. The rate depends on what Province you’re from.

      You can get tall the rates here: http://www.cra-arc.gc.ca/tax/individuals/faq/taxrates-e.html

  8. Leftblank says:

    Interesting article, but I’m afraid it all works quite different here in Europe, most words mean nothing to me 😉

  9. John,

    I agree with most of what you said, good article. The only thing I have to mention is that if you contribute a large amount into your RRSP, enough to drop you to the next tax bracket, you will reduce your tax return. So someone who uses your formula, and is on the border between tax brackets, may have to pay a little more to pay back that RRSP loan.

    FT
    http://www.milliondollarjourney.com

  10. Excellent article. Shows the direct benefits of contributing throughout the year!! Also, it is a great come back to get all the RRSP sales people off your back at deadline time. 🙂

    Chris Spurvey
    http://www.mlm-journey.com

  11. Hey! How would you like it if I started putting up posts about Dining Out in Vancouver or how great it is to be an Internet Tycoon? 🙂

    Good input to your readers, but stick to your side of the street eh? It’s crowded enough on the Financial Blog planet.

    –C8j

    1. Andrew Kuo says:

      John’s only rambling…. If you were to post Dining Out in Vancouver, that wouldn’t be right, you aren’t the rambling Dot Com Mogul 😛

    2. Jeff says:

      The beauty of this blog is that the topics can vary, and they are very random, which creates more of a community-like atmosphere rather than some news site on a specific topic.

  12. Nice article. I didn’t know about the last part

    “take this RRSP receipt to the Canada Revenue Agency and get a letter from them that tells your employer to make source deductions based on your gross income less the amount of your RRSP contribution.”

    I make auto RRSP contributions monthly rather than one lump sum. I guess that means I have to get 12 letters or is there a better way?

    1. John Chow says:

      CRA will not issue 12 letters. You pretty much have to do it as one lump sum. Since you doing monthly contributions, what you can do is borrow the full amount at the start of the year to buy the RRSP. Get the letter from the CRA to give to your employer, then use the extra cash you receive each month to help pay back to loan.

      For example. If you were in the 40% tax bracket and you were putting in $500 per into a RRSP ($6,000 a year), you would borrow $9,500 from your bank, put it all into a RRSP and then get the CRA letter to give to your employer.

      The payment on the $9,500 loan at 5% is $813.27 per month. $500 will come from you, the reminder will come from the $317.00 extra money you’ll get in your paycheck.

      With this trick, instead of putting $6,000 a year into a RRSP, you put $9,500 at the start of the year for one extra year of tax free growth and it didn’t cost your anything extra out of your pocket. Best of all, you’ll get no refund because you have all your money working for you.

      The above is based on today’s Prime rate minus 1%. If you can’t get a RRSP loan at Prime -1, go to another bank.

      * I can’t believe I’m giving Warren Buffett financial advice.

  13. Ryan says:

    Nice article, but definately try to do it before the start of the next year. 😀

    1. Ryan says:

      I have no idea what I am talking about…

  14. Nice little trick, making your money work for you again. Nice tips john im sure alot of people in your neck of the woods will really appreciate this,.

  15. Marc says:

    Definitely sound advice, but while you can’t argue the raw numbers, there’s a lot to be said about the impact of having a paid off mortgage as compared to having more in RRSPs.

    That being said, any money that you don’t end up paying taxes on is free money…

    In either case, I’m too broke for any of it at the moment.

  16. Marc says:

    Urgh… I’m a little slow today. I only just realised the awesome ad fodder this post is. Very evil John, keep it up 🙂

  17. great info. Never too late to start investing.

  18. derrich says:

    50% tax bracket? Good thing I don’t live in Canada.

    *Health Care system*

    😛

    1. Leftblank says:

      50% isn’t that much, some countries go up to 60% 😉 The advantage though is that you aren’t quite screwed when you’re not as lucky, which is kinda happening in the US everyday.

  19. John, speaking of tax time, how will you declare/account for your blog income?

    I see that you posted that you are dividing it up between local charities and a trust fund for your daughter so is the blog income going to be personal income or a tax write-off?

    Make a post about it !!

    1. Michael Kwan says:

      As I understand it, he’ll have to report it as self-employed income, and then grab all of those charity tax receipts and input all of those in the appropriate section. Because he’s setting aside some of it for Sally’s trust fund, I’m assuming that part becomes taxable.

    2. John Chow says:

      Income from the blog is consider business income and must be declared with my personal income tax return.

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