When to deduct RRSP contribution

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fwfuser
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When to deduct RRSP contribution

Post by fwfuser »

Hi,

I'm looking for help with the correct thought process regarding timing of deducting RRSP contributions and the approach I should take. Here are the relevant facts:

- Married (35/36 years old)
- My taxable income 2016: 84,835
- Spouse taxable income 2016: 72,653
- My available RRSP contribution room: 11,919
- Spouse available RRSP contribution room: 24,360

- We are both on DB plans and currently gain roughly 3,000 in additional RRSP room per year
- TFSAs are maxed up to the 2016 allowances
- We do not yet have any non-reg investment accounts set up (but expect to need them soon)

- I expect that my taxable income will increase to about 89,500 for 2017, 96,000 for 2018, and 105,000 for 2019
- My spouse's income will likely increase by about 2% a year

- We have 22,000 in cash ready to be invested right now
- We will accumulate enough other additional cash over the year to max our 2017 TFSA room

I am trying to determine the best approach in terms of whether to use the 22,000 to contribute to RRSPs for 2016 for either of us and if so should we take the deductions now or defer them.
Given that I expect my income to increase as above, I think it would make sense to wait to use my RRSP deductions since I should reach a materially higher MTR within a couple years. So then, the question would be how much to put in spouse's RRSP (uFile calculator says that her tax savings are 33.0% on the first dollar contributed and would be 31.7% if all 22,000 were put in her RRSP. This is not a big drop in the MTR and means we'd be "wasting" less than $300 in total tax refund by just contributing and deducting all 22,000 in her RRSP now). The resulting refund would then go to TFSAs and we'd need to open non-reg accounts later in 2017. OR I could put some of the 22,000 in my RRSP but wait to deduct it.
Any thoughts?

On a related but separate note, what is the correct logic in deciding when to deduct an RRSP contribution? For example, if I make a 1,000 RRSP contribution that I choose not to deduct, I'm foregoing about $330 in tax refund today that I would otherwise invest right now and earn a return of say $20 on by next year. So my decision is based on whether deferring the RRSP deduction until next year would be expected to get me at least a $350 refund?
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Re: When to deduct RRSP contribution

Post by OnlyMyOpinion »

I'm going to jump in with my bias, recognizing that everyone's situation is different so there is no single answer.
i) Utilize both your TSFA and your RRSP fully if you can afford to - before accumulating substantially within your non-regiserered.
ii) Even with a pension, maximize tax-sheltered/tax-deferred accounts - the future is uncertain, pay increases may or may not come, taxes may change, RRSP might be used at baby time, off work time, pension may not be bullet proof, etc. Worse case, retire a few years early early and utilize the RRSP you didn't need or defer the CPP.
iii) Over the years, steer towards 50/50 retirement income stream with spouse as much as possible.
iv) In effect, contribute to RRSP each year and use the reduced tax/refund for TSFA contribution.
v) But, don't funnel everything into saving only for the future - it is the trip we are meant to enjoy, not the destination.
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adrian2
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Re: When to deduct RRSP contribution

Post by adrian2 »

You don't mention the province, so I'm going to use the tax rates for the Centre of the Universe.

You are now in the 34% bracket, moving soon to 43+%. In that case, I would defer taking the deduction.
Your spouse is now in the 29% bracket, potentially moving (or not) to the 31%. That's unlikely to move the needle.

Warning: do not blindly rely on tax brackets. Use tax software with what-if scenarios, as per your current tax situation. Depending on other deductions and credits you may have, you may not be in the "official" brackets predicted.
On a related but separate note, what is the correct logic in deciding when to deduct an RRSP contribution? For example, if I make a 1,000 RRSP contribution that I choose not to deduct, I'm foregoing about $330 in tax refund today that I would otherwise invest right now and earn a return of say $20 on by next year. So my decision is based on whether deferring the RRSP deduction until next year would be expected to get me at least a $350 refund?
Pretty much.
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AltaRed
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Re: When to deduct RRSP contribution

Post by AltaRed »

Ditto to Adrian's response. There are a number of people here who regret having taken the RRSP deduction for a contribution when in 'lower' marginal tax rates....just to find out when they retire that they will be withdrawing under a substantially higher marginal tax rate. There just wasn't resources around 20-30 years ago for some of us to know that risk. All we were told is to take as much RRSP contribution and deduction that one could all the time.

But it seems to me you could retire in the 38% tax bracket if not the 43% tax bracket.... so defer the deduction until you are in the 43% tax bracket. You want to minimize the risk of withdrawing in a higher tax bracket than your deduction tax bracket. As Adrian suggests, run some tax software to be sure.
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kcowan
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Re: When to deduct RRSP contribution

Post by kcowan »

Just to reinforce the point, I contributed to my RRSP for 20 years at a rate below what I pay now. What happens is that your earnings rise dramatically toward the end of your career. The last ten years are amazing! And then you make all this retirement income! Such a problem...
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Re: When to deduct RRSP contribution

Post by OnlyMyOpinion »

To summarize (flippantly) :) :
Utilize RRSP deduction in highest taxable working years to defer maximum taxes, end result = more money > Good
Save too much in RRSP and face higher taxable income in retirement than while working, cause = too much money > Bad
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Re: When to deduct RRSP contribution

Post by Spudd »

Also, if you put the money in the RRSP now but do not use the deduction now, it's still sheltered from tax immediately, so worth doing.
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Re: When to deduct RRSP contribution

Post by AltaRed »

Indeed. Make all the contributions one can. The only decision is when to take the deduction.
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izzy
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Re: When to deduct RRSP contribution

Post by izzy »

The objective is to smooth your income over your lifetime NOT to save as much tax as possible.If you live to 100+ you ideally don't want to live your last years in penury,The price of success is a higher tax bill in your estate if you die younger.This seems a reasonable bargain to me.Its similar in some ways to the choice one makes in buying an annuity.You COULD of course save all the deductions for use by your estate I suppose :lol:
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Re: When to deduct RRSP contribution

Post by fwfuser »

Thanks everyone for the helpful replies. I will contribute all the available funds to our RRSPs in order for it to grow tax-free and I'll defer the deduction from my RRSP. I think I'll contribute 17K of the 22K into my spouse's RRSP. As for her deductions, as suggested I used our otherwise completed UFile data for 2016 and I ran a number of scenarios with different RRSP deduction amounts to get the "real" refund amounts. The following is now more of an academic exercise, but is interesting for me and perhaps some of you too. It is difficult to explain clearly but I hope I've done OK. If correct, it implies that I should possibly spread the deductions over a number of years.

For simplicity, I have assumed that her 2016 tax profile will apply to all future years (ie that she's always in the same bracket as now, etc.). Then I made scenarios to compare deducting the full 17,000 in 2016 versus deducting 2,000 per year for 9 years, versus deducting 3,000 per year for 6 years, etc (the last year has a deduction of the residual to get to 17,000). This was done for a series of different assumed annual returns that would be earned on the annuity of tax refunds received.

What I get is the chart linked below, which represents the future value 10 years from now of the invested tax refunds associated with today's 17,000 contribution. Each line represents an assumed annual rate of return. The X-axis represents the annual amount deducted (as described above). It suggests that if I achieve low annual returns on invested tax refunds, I'm better off taking a long series of small deductions rather than taking larger deductions. I think the logic is that smaller deductions recapture a higher MTR, which outweighs investing a larger refund at a lower MTR at a weak rate of return.

Now, my actual 3 year investment XIRR is 7.3% on an index portfolio so perhaps I'm best to just deduct the whole 17,000 this year, but to the extend that my spouse moves to a higher bracket in future years, that adds strength to using several smaller deductions.

I know this is practically the definition of over-analysis, but I found it interesting and also, barring fatal flaws in the approach, it might influence my general future approach to taking RRSP deductions.

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adrian2
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Re: When to deduct RRSP contribution

Post by adrian2 »

fwfuser wrote:t suggests that if I achieve low annual returns on invested tax refunds, I'm better off taking a long series of small deductions rather than taking larger deductions. I think the logic is that smaller deductions recapture a higher MTR, which outweighs investing a larger refund at a lower MTR at a weak rate of return.

Now, my actual 3 year investment XIRR is 7.3% on an index portfolio so perhaps I'm best to just deduct the whole 17,000 this year, but to the extend that my spouse moves to a higher bracket in future years, that adds strength to using several smaller deductions.
To elaborate on the over-analysis, keep in mind that, as you may have filled all your tax protected space, you may have to invest the refund in a taxable account, where is less likely you'll achieve the past XIRR.
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Re: When to deduct RRSP contribution

Post by StuBee »

fwfuser wrote:What I get is the chart linked below, which represents the future value 10 years from now of the invested tax refunds associated with today's 17,000 contribution. Each line represents an assumed annual rate of return. The X-axis represents the annual amount deducted (as described above). It suggests that if I achieve low annual returns on invested tax refunds, I'm better off taking a long series of small deductions rather than taking larger deductions. I think the logic is that smaller deductions recapture a higher MTR, which outweighs investing a larger refund at a lower MTR at a weak rate of return.
Here is a simpler interpretation of your "over-analysis":

No matter what you do, if you assume a total return of 4% (or even 3%...) or more, the end result will be the same.

I realize that the corresponding graphs I am referring to are not flat. But, over a ten year period, there are so many other things that could take place that the non-flatness of the graphs will be lost in all the "other noise".
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Re: When to deduct RRSP contribution

Post by dwarren »

Are there any other options for the money other than RRSP, e.g. Consumer Debt, Mortgage, RESP. A crazy couple's trip before kids (if they are in your future)? With two DB plans, are there other life goals that the money can go towards?
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Re: When to deduct RRSP contribution

Post by ostrich »

On a perhaps tangential note, I always assumed that if you're in the highest bracket (which I am), and you've got enough available unused contribution, that it makes sense to apply as much of the contribution as a deduction as it takes to essentially get you out of the highest bracket. After that whatever additional amount you apply as a deduction is less effective, since the tax savings you're getting from that point is at a lower rate. So if you're starting to get into lower and lower brackets you may be better off saving that room until a later year when it will again represent a saving at the highest rate. Is that a valid characterization?
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Re: When to deduct RRSP contribution

Post by AltaRed »

It is...to a point. The key is to have a crystal ball and guess what your marginal tax rate will be when you have to withdraw, and make sure your deductions do not put you in a lower MTR than you will be in... during withdrawal. Good luck on determining that beyond a best guess. Depending on your confidence on accumulating wealth, assume the tax bracket you will most likely be in at retirement time.

Course gov't could change all the rules and throw all best planning out the window. I just wouldn't take deductions that would put me in the bottom 2 federal tax brackets, and I might limit it to not dipping into the bottom 3.
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optionable68
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Re: When to deduct RRSP contribution

Post by optionable68 »

Then again, Maxime Bernier could conceivably be our net Prime Minister, which could mean flat 15% income tax from $15k to $100k and 25% over $100k.... and by deferring you may have lost out on a better refund today.
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Re: When to deduct RRSP contribution

Post by 2of3aintbad »

Suppose that you have made a contribution, but have not claimed the deduction. What is the maximum age, if any. to claim the deduction? I know you cannot make a contribution beyond age 70, but can you save your deduction indefinitely?
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Re: When to deduct RRSP contribution

Post by epson600 »

Assuming you live in Ontario your spouse should at least deduct $653 to bring taxable income down to 72k. With the way the Ontario Health Premium is calculated spouse would be saving $150(or about 25%) on top of the regular tax rates.

Not too much in the big picture, but hey, not too many times you can say you got just shy of 55% deduction :)

Ontario Health Premium extra tax rate
48000-48600 25%
72000-72600 25%
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Re: When to deduct RRSP contribution

Post by izzy »

2of3aintbad wrote:Suppose that you have made a contribution, but have not claimed the deduction. What is the maximum age, if any. to claim the deduction? I know you cannot make a contribution beyond age 70, but can you save your deduction indefinitely?
I think so.Remember you cannot make a contribution to your OWN plan if you are over 71 but you can still contribute to a spousal plan if he/she is younger than that and you have contribution room e.g.from continuing employment or real estate rental income.
My (tongue in cheek) suggestion of deferring the deduction for use by your estate on your final tax return though was not a serious one though I suppose it might work in some circumstances.
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Re: When to deduct RRSP contribution

Post by queerasmoi »

Me, I created quite a chunk's worth of an RRSP deduction in January and March 2013 when I kicked my entire US & International side of my portfolio into newly-created room after becoming gainfully employed. However that did not last long and I was laid off that May. My 2012 tax return deducted about half that RRSP amount. The rest, I carried forward in 2013, during which I'd only had 5.5 months' full-time employment plus EI...
... and 2014, when I had maybe 2 months of a job at all
... and 2015, when I had even less income and went back to school
... and 2016, when I had 4 months of school, 4 months of a co-op job and finally 4 months of the best-paid job I've had in my life
... and, fingers crossed, 2017 will be the highest annual income I've had in my life (nearly double my annual salary from the 2012-13 job), and I will finally take the deduction.

Relevant question: Would there be any sense in going back and revising my 2013 return to carry forward the deduction and pay the difference, and then collect it back for 2017 at a higher rate? Would the CRA allow this? Would I also have to submit a reassessment for 2014, 15 and 16 to make it happen properly?
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Re: When to deduct RRSP contribution

Post by epson600 »

queerasmoi wrote:Relevant question: Would there be any sense in going back and revising my 2013 return to carry forward the deduction and pay the difference, and then collect it back for 2017 at a higher rate? Would the CRA allow this? Would I also have to submit a reassessment for 2014, 15 and 16 to make it happen properly?
If I am reading it correctly; you should be able to. Or at least I did a couple of years ago, though I only went back one year. I went on MyAccount and filled a change on a previous years return by lowering the RRSP deduction. I then used that contributed but not deducted room on the current years return to get out of the ~51% tax rate caused by EI clawback due to taking the CV of a DB pension from my previous employer.

I obviously had to pay the taxes owed for the undeducted amount, plus the interest charged for 9 month or so. In your case I would assume that you would need to pay the interest for the 3 years... You'd have to figure out the math on that one.
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