TAX MATTERSBy Tim Cestnick, a tax commentator for television’s CBC Newsworld, Canada AM, and ROBTv. He is also guest tax columnist for Canada’s national newspaper, The Globe & Mail.
TORONTO (Globe and Mail), February 7, 2008:
My grandfather used to tell me that there are three kinds of people: Those few who make things happen, the majority who watch things happen, and those who have no idea what happened.
When it comes to setting aside money for retirement, you don't want to show up at your retirement party and then realize you simply watched as the rest of your friends made their retirement savings happen. And so, it's time to get some savings into your registered retirement savings plan (RRSP).
CONTRIBUTING IN-KIND
Borrowing to contribute to your RRSP can make good sense. One of the drawbacks, however, is that you can't deduct the interest costs on an RRSP loan. And so, there may be a better option if you already have investments outside of your RRSP.
You could, for example, transfer some of your investments held outside of your RRSP into your plan. This contribution in-kind is much like contributing cash. You'll be entitled to an RRSP deduction for the fair market value of the investments on the day you make the transfer to your RRSP. You could then borrow to replace those investments outside your RRSP, which will generally provide you with a deduction annually for any interest on the loan.
Make sure you have sufficient RRSP contribution room to make the transfer to your RRSP. Also, if the investments have appreciated in value, you'll trigger a taxable capital gain when making the transfer to the RRSP (although the RRSP deduction will more than offset that taxable amount provided you have sufficient contribution room).
In addition, if the investments have dropped in value, you won't be able to claim the capital loss if you transfer the investment directly into your RRSP. In this case, you'll be better off to sell the investments on the open market, which triggers a capital loss you can claim, and then contribute the cash to your RRSP.
TOP-UP LOAN
Okay, so you don't have investments outside your RRSP to make a contribution in-kind. Consider borrowing to contribute to your RRSP. An RRSP top-up loan will allow you to increase the amount you'd otherwise contribute this year. The sooner you can pay that loan off, the better.
So, consider borrowing enough to contribute to your RRSP to create a total tax deduction, and potentially a tax refund, sufficient to pay off the entire loan all at once. Consider an example.
Suppose you contribute $5,000 of your own money to your RRSP this month. If you were to borrow an additional $4,092 this month and contribute this to your RRSP, you'd now have total RRSP contributions of $9,092, which can be deducted on your 2007 tax return. If your marginal tax rate is 45 per cent, you can expect a tax refund of $4,092 from this deduction - about the right amount to fully pay off the RRSP loan.
How do you figure out the amount to borrow to create the tax savings that will pay off the debt? Simple. The amount to borrow should equal the amount of your own money contributed, divided by the following formula: 1/MTR - 1 (where MTR is your marginal tax rate). If your MTR is 45 per cent, the formula looks like this: 1 divided by 0.45 is 2.222, subtract 1 equals 1.222. If you contribute $5,000 of your own money, take $5,000, divide it by 1.222, and the answer is $4,092 - the amount to borrow.
CATCH-UP LOAN
Let's face it. If you've been allowing your contribution room to accumulate over the years, you could have a significant amount of available contribution room today. You're probably also behind in saving for retirement. It's likely you won't be able to pay off a significant loan in one year.
It can make sense to take out an RRSP catch-up loan for some larger amount to supercharge the amount in your plan. Paying off a catch-up loan over five years can still make sense.
Suppose you're able to afford a $300 monthly payment on an RRSP loan. If you were to extend the loan over, say, five years, the amount you could borrow would be about $16,000 based on typical RRSP loan rates today. Over the term of five years, you'd pay about $2,653 in interest to the bank, but you would have deferred taxes of $7,200 this year by making a $16,000 contribution, assuming a marginal tax rate of 45 per cent. The value of that tax deferral will outweigh the interest costs over the several years you have until retirement.
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