Wednesday, January 26, 2011

When it makes sense to borrow for your RRSP

Loans are a part of life for most Canadians. We take out loans to pay for our cars and our homes, for vacations, furniture and TVs. And, at this time of year, as the deadline for making your 2010 Registered Retirement Savings Plan (RRSP)contribution looms, you may be asking yourself if it makes sense to make one more loan – a loan to increase your RRSP contribution.

The right answer for you depends on the overall shape of your financial life. Let’s look at the factors you should consider.

Makes sense to borrow …
  • Because contributing to your RRSP can pay off in two ways: First, you’ll increase the size of your tax refund; second, you’ll have more tax-deferred money growing inside your retirement plan. But the first rule is this: The loan must fit your budget.
  • When you intend to pay off the loan within a year. Remember: Interest on an RRSP loan is not tax-deductible. Consider a series a smaller RRSP loans with payments within your budget. Longer term loans are more suitable for purchasing non-registered investments (when the interest is tax deductible).
  • When size of the loan maximizes tax savings. Tax rates rise with income. More tax can often be saved by spreading RRSP deductions over more than one year. While contributions made in one year can be deducted in a future year, it does not always make sense to borrow to make an RRSP contribution if it will take several years to fully utilize the deduction. Again a series of smaller loans may produce the better financial result.
  • When you use your tax refund to pay off the loan as quickly as possible.

Or maybe not …
  • If you expect to be taxed at, or near, the lowest marginal rate over time. In that case, you won’t get the full tax-reduction benefit of making your maximum RRSP contribution, so the cost of taking out an RRSP loan doesn’t make sense. Instead, you might want to consider contributing to a Tax-free Savings Account (TFSA). The contribution isn’t tax deductible but money and interest inside a TFSA is tax-free and, unlike your RRSP, so are withdrawals, which can be made at any time for any purpose.
  • If your increased RRSP refund is already earmarked, in whole or in part, to pay taxes you owe on other income.
  • If you are unsure your income level will allow you to meet your RRSP loan obligations, which you will be required to do regardless of your income level and the performance of your RRSP in the shorter term.

Borrowing to increase your RRSP contribution can be a useful strategy but it also comes with specific risks. Perhaps you can avoid the need to borrow next year through a Pre-Authorized Contribution (PAC) plan that automatically deducts and saves any amount you want from your regular paycheques.

And, of course, your professional advisor can help you map out the RRSP contribution strategy that fits the overall shape of your financial life.

Wednesday, January 19, 2011

RRSP fast facts – what you need to know to save and grow

The deadline for making your 2010 Registered Retirement Savings Plan (RRSP) contribution is fast approaching – but you still have time to take advantage of a few last-minute RRSP facts and tips that will reduce your tax load this year and help build a financially comfortable retirement.
  • Don’t miss the deadline. This year’s contribution deadline is March 1st, 2011
  • Maximize your RRSP contribution. The best strategy is to always make your maximum allowable contribution each taxation year. That way, you’ll get the most in immediate tax savings and maximize the potential long-term growth of the investments in your RRSP. You’ll find your personal maximum allowable contribution room on your most recent notice of assessment from the Canada Revenue Agency (CRA)
  • Catch up on past contribution room. You can fill your unused contribution room in a single year or over a number of years until the year you reach age 71 – but the faster you fill it, the better for additional tax savings and longer term tax-deferred, compound growth
  • Borrow to save. Taking out an RRSP loan can be a smart way to maximize this year’s contribution or to catch up on your past contributions. The key is to get a loan at a low interest rate and pay it back as quickly as possible. You can even use your RRSP tax savings to help pay off the loan
  • Split income to save. While you can take advantage of the pension income splitting rules in retirement, in the right situation, a spousal RRSP can still make sense to save taxes in your retirement
  • Diversify for better growth. The government caps the amount you can contribute to your RRSP(s), so it’s highly likely you’ll need additional income to afford the retirement of your dreams – and that’s where a Tax-Free Savings Account and your non-registered investment portfolio comes in. A well-balanced portfolio is based on an asset allocation plan that matches your risk profile and time horizon
  • Choose an RRSP beneficiary. You can designate a beneficiary on your RRSP (in Quebec, this must be done through the Will). If you die without a beneficiary designation, up to 48% of your total RRSP value could be lost to taxes. Generally speaking, the RRSP assets do not form part of your estate and, therefore, do not attract probate fees. And, if your beneficiary is your spouse (or a disabled dependent child or grandchild) your RRSP may be transferred on a tax-deferred basis to your beneficiary’s registered plan
With the right RRSP strategies wrapped in a sound, overall financial plan, you will save on taxes every year and retire with more. Your professional advisor can help make your future dreams into a financially secure reality.