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Cameron Passmore CIM, FMA, FCSI

Portfolio Manager

Benjamin Felix MBA, CFA

Associate Portfolio Manager
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  • 1.800.230.5544
  • F613.237.5949
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  • Ottawa, Ontario K1S 2E1

Getting carried away with the RRSP deduction

February 24, 2016 - 0 comments

It is common for Canadians to make last minute RRSP contributions in order to claim the deduction and receive an immediate tax refund. While satisfying, using the RRSP deduction in the same year that a contribution is made can be suboptimal if a person’s tax rate is increasing from one year to the next. This can be illustrated with two cases.

An individual with a 2015 income of $150,000 and a 2016 expected income of $300,000 makes a $20,000 RRSP contribution before the 2015 RRSP deadline. We will assume that when they use the deduction, their tax refund is received at the end of the year that it is used, and is then added to the RRSP account. Investment growth over the relevant time period is assumed to be 5%.

Case 1: Use the Deduction in 2015

A 2015 taxable income of $150,000 sits at the top of the 46.41% tax bracket. Using the $20,000 deduction will result in a deferral of $9,282 in taxes. Reinvested immediately in the RRSP, the total account value at the beginning of 2016 is $29,282. This grows to $30,746 by the end of 2016.

Case 2: Carry Forward the Deduction to 2016

A 2016 taxable income of $300,000 is well into the 53.53% tax bracket. $20,000 contributed to the RRSP at the end of 2015 grows to $21,000 by the end of 2016, at which time the carried forward $20,000 RRSP deduction is used, resulting in an income tax deferral of $10,706. The end result is $31,706 in the RRSP at the end of 2016.

  Case 1 Case 2
2015 RRSP Contribution 20,000 20,000
2015 tax deferral 9,282 -
2015 growth 1,464 1,000
2016 tax deferral - 10,706
2016 RRSP balance 30,746 31,706

Assuming a 5% rate of return, Case 2 results in a 3% greater RRSP balance than Case 1. If it could be known that the market would have strong returns in 2016, it would be preferable to claim the deduction in 2015 and invest the refund. For example, Case 1 will become more favorable than Case 2 once the 2016 rate of return is at or above 12%. However, with a foggy crystal ball, deferring the deduction to 2016 results in a more reliable outcome.

At tax time, it is prudent to be strategic with the RRSP deduction to maximize its benefits.

By: Ben Felix with 0 comments.
Filed under: Financial Planning
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