I know we're tired of being told to "just save money" but here are 6 ways you can use RRSP contributions to strategically maximize your tax savings while minimizing your tax owing.
You'll want to read until the end because I saved the best for last.
1. Increase your refund
Let's start off with the most basic one. You can utilize your RRSP to increase your refund on your tax return.
When you contribute money to your RRSP you get a dollar for dollar tax deduction. Tax deductions help to reduce your total payable aka how much money the government wants you to pay tax on.
For example:
Let's say you made $60,000 in 2023 BUT you contributed $10,000 to your RRSP. In the eyes of the government you only made $50,000 and you will only be taxed on $50,000.
RRSP contributions can mean SIGNIFICANT tax savings, especially for high income earners.
That leads me to my next point.
2. Change/Adjust your return after the year is over
The thing I love most about RRSPs other than their huge tax saving benefits is their ability to be used in extremely strategic ways. Let me explain.
In Canada our tax year runs from January 1st-December 31st meaning once the clock strikes midnight on December 31st and we flip into the new year all of your income, credit, & deductions (read: tax stuff) are set in stone. There is nothing you can do to change your numbers now EXCEPT using RRSP contributions.
This is because, unlike everything else that runs from January 1st- December 31st, RRSPs run from 61 days into the tax year (usually March 2nd except on leap years) until 60 days into the current year.
That means if I contribute $5,000 to my RRSP on February 10th, 2024 it actually counts towards my 2023 taxes!
Note: you have until February 29th, 2024 to contribute to your RRSP and have it count towards your 2023 tax return.
It is exciting because it means you can use your RRSP contributions in an extremely strategic manner once you're aware of the RRSP time periods.
Let's talk about how you can use the RRSP time period to maximize your tax savings and reduce your tax owing.
3. Bump you into a lower tax bracket
Now here is where things start to get really exciting! Because you have an 'extra' 60 days to contribute to your RRSP and get the benefit on your prior year's tax return you can do a mock-up of your tax return before the RRSP contribution deadline to see where you are currently at.
When you do this, let's say that you see that your taxable income is just over the tax bracket threshold, so instead of paying 20.5% on that money you are now paying 26%.
If you have the funds available you can contribute the difference between where your current taxable income is at and the top of the previous tax bracket to your RRSP and bump yourself into a lower tax bracket!
For example:
You made $110,000 in 2023
The 20.5% federal tax bracket is for income between $53,360 and $106,717
Since you made $110,000 you are $3,283 over the 20.5% threshold
This means that you are now paying 26% on that $3,283 which works out to $853.58 in taxes!!
If you contributed that $3,283 to your RRSP all of your income would now fall under the 20.5% threshold so you would be saving the tax on that money while still being able to keep it in your pocket. Win-win.
4. Counteract a balance owing
Another great thing RRSP contributions can do is counteract a balance owing. If you come see me in January or early February I am able to do your return before the RRSP deadline.
If you have a balance owing I can calculate how much you would need to put into your RRSP to counteract the balance owing.
You can even use RRSP contributions to wipe out a balance owing from a prior year by increasing the current year's refund to take care of that previous balance owing.
5. Counteract additional income that was undertaxed
Like counteracting a balance owing, RRSP contributions can also counteract undertaxed income, bonuses, and side money.
It is common to have a lower refund or balance owing if you have multiple jobs since each employer takes enough tax individually but when added together not enough is taken on the total.
It's also common to have a balance owing or lower refund when you are on EI and maternity leave. This is because EI is only taxed at 10% and the lowest federal tax bracket is 15%. The tax discrepancy is even larger if you are in higher income brackets before going on EI.
You can use RRSP contributions to counteract income from unexpected sources like capital gains, dividends, and interest as well as income from self employment income and rental income.
6. Stock up your RRSP deductions to use in the future for a greater impact
I may have saved the best for last.
Let's say you're reading this and you're in university and not making that much money, or maybe you're making $50,000 right now so all of your income is still in the first federal tax bracket, or maybe you're making good money but you know in 2 years you're going to sell your rental property and have a massive influx of taxable income that year.
With RRSP contributions you can choose when to apply the deduction on your tax return! You can choose to not claim them in the year you contributed and instead wait to claim them in a year where they will have a greater impact. These RRSP contributions can be carried forward indefinitely with no expiration.
This is great because you can still have that money in your RRSP taking advantage of compound interest, where TIME is the most important factor, while also being strategic about when to claim that deduction to have the greatest benefit on your tax return.
As an additional bonus, since that money is inside your RRSP all the interest, dividends, gains etc. are also tax free.
So you have the advantages of
Compound interest & time in the market
Tax free interest, dividends, & gains
Timing your deduction for maximal tax saving impact
Win- win -win!
Here is how waiting to claim the RRSP deduction would help each person I listed the example above.
Students:
As a student you typically are not making much money-but the trade off is that when you complete your schooling you'll be able to get a high paying job.
If I was a student I would still contribute to my RRSP to take advantage of the 3 things I listed however, I would save my RRSP deduction until I was out of school making good money. To go even farther I may wait to use my RRSP deductions until I was out of school, making good money, and I had already used up my tuition credits.
Lower salary ($53,000 or less) to a higher salary ($55,000 or more):
Similar to the student example if I was making under $53,000 I would still be in the first federal tax bracket at 15%.
If I knew I would be earning over $55,000 in the next handful of years I may want to wait to claim my RRSP deduction then to take advantage of the larger tax savings that come from being in a higher tax bracket like a 20.5%, 26% or even 29% tax rate.
Typically this applies to people where they are just starting out, or they are in a position where their starting salary was lower, or they are on EI/benefits for a period of time.
A future higher than normal income year:
The last example I touched on was if you have a stable income, even a high stable income, but you know that in the coming years you will have a year or two with an abnormally large taxable income.
In this case you could contribute to your RRSP to take advantage of the 3 things I listed and stockpile your RRSP contributions to prepare for when that cash influx comes. Once that income influx hits you would be able to leverage your banked RRSP contributions and claim them against that income to really minimize that additional income spike.
These large income influxes usually come from a capital gains like a massive gain from the sale of stocks, bonds, ETF and things of that nature, as well as real estate.
By using these 6 tips you can see how utilizing the different benefits of the RRSP add up to an extremely tax efficient strategy. I hope this allows you to plan better to keep more of your money.
Which one are you most excited about?
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