RRSP Deadline Looming on March 1

For many taxpayers, the end of February marks the deadline for the annual ritual of contributing to their RRSP.  This year the contribution deadline for 2016 is March 1, 2017.  But is this last-minute rush to contribute the best course of action?

Probably not.  Taxpayers now have a choice of vehicles for retirement savings – the RRSP and the TFSA.  For some the TFSA is the best choice.  For those who would be better off using an RRSP, saving monthly is actually a much better way to manage these saving than trying to come up with a lump sum in February.

Ultimately, RRSPs are tax efficient if the tax savings rate on contribution is less than the tax rate on withdrawals.  They can also be efficient if the rate on contribution is equal to the rate on withdrawal because of the time value of money:  the taxes not paid today can be invested in a TFSA on the refund is received.  Further, earnings will grow on a tax deferred basis until a later date, with dollars that would have otherwise decreased in value due to both taxes and inflation.

The important factor then, is to find out your current marginal tax rate – that’s the rate that will determine the tax savings by making a contribution.  Then, anticipate the expected marginal tax rate on withdrawal – in most cases that should be in retirement.

Clawbacks of social benefits are an important factor both on contribution and on withdrawal.  Consider how much more you will receive from the Canada Child Benefit, for example, or the Employment Insurance or Old Age Security, because you have made the RRSP contribution.

Taxpayers who are subject to clawback of CCB and/EI will have much larger marginal tax rates than the tax tables imply.  CCB clawback rates range from 3.2% for families with one child and income over $65,000 to 23% for families with four children and income between $30,000 and $65,000.  Taxpayers who are subject to clawbacks of EI will save an additional $15 in clawbacks for each dollar contributed to an RRSP.

As a general rule, taxpayers in the lowest tax bracket may wish to consider whether they should use the RRSP to save for retirement as opposed to the TFSA.  This is because they will be unlikely to be paying tax on RRSP withdrawals at a lower rate in retirement, while the savings in the TFSA will be withdrawn on a tax free basis.

However if the CCB clawback rate for the family today is 23%, it turns out the combined marginal tax rate is about 43%, depending on the family’s province of residence.  These low-income taxpayers could save significantly by making an RRSP contribution – on their tax savings and refundable tax credit increases - even if the money is withdrawn before retirement.

Higher-income taxpayers will generally benefit the most by using RRSP contributions.  Where income in 2016 exceeds $200,000, the tax rate on income is at its highest; quite likely it will be lower in retirement.

On withdrawal, seniors, too,  have other issues to consider besides taxes payable. Clawbacks of the Age Amount will add 20% or more, depending on the province, to the tax rate for income between roughly $36,000 and $80,000.  Clawbacks of OAS will add 15% to the tax rate for incomes between roughly $75,000 and $120,000; there these circumstances substantially boost the marginal tax rate.

Clearly the vehicle of choice in retirement is the TFSA for these reasons, as any cash taken from the TFSA to supplement other income source will as zero to the retiree’s tax bill.  However, at this point in time, TFSA balances are likely not enough to provide a decent retirement income – although they certainly may be in the future.

For a tax efficient retirement, pre-retirees today will want to diversify savings in order to have a choice of withdrawal options that provide the right level of net and taxable income with maximized social benefits, too.

Remember, the RRSP provides the flexibility to withdraw a little or a lot until the end of the year in which the taxpayer turns 71, after which there are minimum withdrawals from the fund when savings have been converted to a RRIF.  The key  drawback is that the withdrawals are  taxed as ordinary income (100% added to income).  Avoid this tax inefficiency by planning to withdraw smaller amounts over a longer period of time, especially for taxpayers in the clawback zones mentioned above.

Regardless of whether it’s the best course of action or not though, a late RRSP contribution for those with higher marginal tax rates due to income level or access to tax credits and their clawback zones, is better than no contribution.

If you’ve not made your RRSP contribution for the 2016 tax year yet, see your tax professional immediately to determine the optimal contribution, which must be made by March 1, 2017. Then, start planning to reduce your taxes for 2017 and beyond, as part of your planning for your enhanced tax refund.

Walter Harder, DFA- Tax Services Specialist is a Master Instructor with Knowledge Bureau, and co-author of several certificate T1 Tax Courses in the DFA-Tax Services Specialist Program™.

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