The bigger bang RRSP strategy

Tax Managed Strategy 24

For many Canadians, as the calendar year winds down, the time comes to think about making your annual contribution to your registered retirement savings plan (RRSP). Whether you contribute regularly to your RRSP throughout the year or if you make a single lump-sum payment or additional top-up payment closer to the RRSP deadline,1 there’s a strategy you need to consider.

Typical scenario

A typical scenario may involve working with your advisor to determine the amount of the RRSP contribution you’ll make to help reach your retirement goals. However, it’s not uncommon that you may have less cash on hand than the amount of the RRSP contribution you’d like to make. So, you commit the amount of funds you can afford now, promising yourself that you’ll invest the tax refund when you receive it.

The numbers

Take, for example, an individual who has $7,000 in cash with a marginal tax rate of 40%. If this person were to contribute this amount in the first 60 days of 2023 a deduction can be claimed on the 2022 tax return. This will result in a tax refund of $2,800 ($7,000 × 40%), which can be contributed to an RRSP and a corresponding deduction claimed on the 2023 tax return. Although the tax refund of $2,800 can’t be claimed until filing the 2023 tax return, the total RRSP contribution increases to $9,800. While this is a better strategy than simply spending the refund, there’s an alternative that can allow you to increase your RRSP contribution in the current year with very little cost.

The bigger bang strategy

This strategy2 works by getting an RRSP loan in the amount of your estimated tax refund in the first 60 days of the calendar year and then using the tax refund to pay off the loan when you receive it. The bigger bang RRSP strategy results in a larger RRSP contribution while allowing you to claim a deduction in the current year. It also puts more money to work for you sooner in a tax-sheltered investment.

The formula

Here’s how to calculate the loan amount you can get so that when you receive your tax refund, you can pay off the loan completely:

Open parenthesis, Cash on hand times marginal tax rate, close parenthesis, divided by, open parenthesis, 1 minus Marginal tax rate, close parenthesis.

Using the above example of $7,000 cash on hand with a 40% marginal tax rate, you can borrow up to $4,667:

Open parenthesis, $7,000 times 40%, close parenthesis, divided by, 60% is equal to $4,667 loan. For illustration purposes only.

For illustration purposes only

The bigger bang

By borrowing an additional $4,667, you’ve increased the overall contribution to your RRSP by $1,867 ($11,667 versus $9,800, as seen below) and you’re able to use the full amount as a deduction in 2022.

Let’s look at how the two scenarios compare:

This table illustrates how borrowing an additional $4,667 to contribute into your Registered Retirement Savings Plan can increase your overall contributions while also allowing you to claim a deduction versus reinvesting your tax refund. For illustration purposes only. Years in brackets represent year of the tax return.
For illustration purposes only. Years in brackets represent the year of the tax return.

The cost

In looking at what this strategy will cost you to implement, you’ll see it’s minimal:

This table illustrates that the cost needed to implement this strategy is minimal. For illustration purposes only.

*An interest rate of 5.95% is used for the RRSP loan in this example. For illustration purposes only.

Depending on when and how you file your tax return, your refund should take no longer than eight to 10 weeks to receive. Tax returns that are filed early using electronic filing methods are often processed by the Canada Revenue Agency within 10 days. As the example shows, even if it’s assumed that it took 90 days to receive your refund and you paid off the loan immediately, the costs not covered by the refund would only be $68.

What to look for in an RRSP loan

Many institutions offer RRSP loans at very competitive interest rates, and some will defer payments long enough so that you have plenty of time to receive your refund before making the first installment. Interest accrues on the outstanding balance, but the loan can be paid in full without penalty at any time.

Ideal candidates

The bigger bang RRSP strategy is best suited for investors who:

  • want to make an RRSP contribution in the first 60 days of the calendar year
  • have less cash on hand than the amount of RRSP contribution they’d like to make
  • have enough RRSP contribution room.

Take action

Take advantage of the bigger bang RRSP strategy:

  • Determine the RRSP loan amount that will equal your estimated tax refund for the year and then take out a loan in that amount (or less).
  • Use your tax refund to pay off the RRSP loan.

Advisors can review the bigger bang strategy presentation deck (log-in required).

1 The RRSP deadline is 60 days following the end of the year. 2 The strategy assumes that there are no other factors that would impact the total tax refund.

Borrowing to invest in an RRSP may not be appropriate for everyone. You will need the financial means to meet your loan obligations. Talk to your advisor to find out more about the advantages and obligations of borrowing to invest.

The commentary in this publication is for general information only and should not be considered investment or tax advice to any party. Individuals should seek the advice of professionals to ensure that any action taken with respect to this information is appropriate to their specific situation. Manulife, Manulife Investment Management, the Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.

MK2725E 11/22

Tax, Retirement & Estate Planning Services Team

Tax, Retirement & Estate Planning Services Team

Manulife Investment Management

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