RRSP Contributions

by Mike Holman

After getting some interesting comments yesterday in my post about what to do with my year end bonus I decided to do a post about rrsp contributions and the best way to do them.  Please check this page out for up to date rrsp deadline information.

One of the suggestions was to put the bonus into the rrsp and use the tax refund to pay down the mortgage. I’m not a big fan of this rule of thumb because it doesn’t necessarily fit everyone’s situation. Some people should put all their extra money into their mortgage and forget about their rrsp. Others should do the opposite and put it all into their rrsp. Most people should probably do some combination of rrsp contribution and extra mortgage payments.

Most people make rrsp contributions by setting up an automatic withdrawal plan from their bank account. Then they will recieve a tax rebate the following spring which is not a good thing because it means that you have made an interest free loan to the government. Another problem is that if you are trying to maximize your rrsp contribution, it is difficult to do with after-tax money. If you can make the contributions with your pre-tax then it will be a lot easier.

A better way to contribute is to get your company to reduce your income tax deductions at the source (your employer) by an appropriate amount so that you pay less tax on each paycheque and will not get a refund at tax filing time.

How do you do this? Most companies that have group rrsp plans will be able to accomodate this if you are contributing to the group rrsp plan. It’s best to talk to your payroll department to see what they can do.

Another option is to fill out a government form T1213 – you send it in and they will send a letter (hopefully) allowing your employer to reduce your deducted income taxes. This can be done on salary or a lump sum amount. This form has to be filled out once a year.
Obviously if you get a reduction in your income tax then you have to make sure you actually make the contribution otherwise you’ll owe quite a bit of tax the following spring.

An example:

If Sue is in the 40% tax bracket and decides to contribute $500/month then her employer will reduce the tax deducted by $500 * 40% = $200 per month. By doing this she is contributing the $500 from her gross salary, not her after tax salary and will avoid giving the government an interest free loan.

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{ 13 comments… read them below or add one }

1 moneygardener

Interesting post.

I don’t believe it is as cut and dry as you describe. It really depends on several other factors including your pay structure, and if your employer is taxing your correctly in the first place. Also, the ‘interest free’ loan can sometimes only be created by very late contributions, and the amount received can offset taxes to be paid on other forms of income (ie dividends, cap gains).

2 FourPillars

MG – Excellent point!

I forgot to add a qualifier about having the appropriate amount of tax removed in the first place which doesn’t always happen.

Certainly having non-registered investments will change the taxation as well. Even still, in theory if you owe money because of dividends etc you are better off saving that tax money and get interest on it (thereby generating more taxes) and pay it when it’s due. In reality it might be just easier to not owe or receive anything at tax time.

Mike

3 moneygardener

I agree with you, and I have to admit the idea never occured to me..

4 telly

Great post!
Does anyone know if CRA will allow you to reduce your taxes deducted (using form T1213) if you have previously (i.e. last 3 years) OWED them money in April?
Our tax situation is much different this year but I wonder how CRA would view this.

5 Wooly Woman

Hi Mike! I came across your blog not too long ago. Good point about interest free loans to the government, this has always bothered me that when they owe us money it is interest free, but not if the situation is reverse!

6 FourPillars

Telly – I have no idea. Best thing to do is give them a call. Or just apply and see what happens.

Wooly – I was late paying taxes one year and the extra fees and interest were ridiculous.

Mike

7 Investing911

@ TELLY – It depends on why you have owed money in the past three years. If it is recurring then you can certainly fill out T1213 and get the tax deducted at source reduced.

8 FourPillars

Investing911 – if she has owed tax for three years then she should get the tax deducted increased, not reduced.

Mike

9 Investing911

@ Fourpillars,

Sorry, I was tired when I was thinking this out. I guess my answer now is that if one of the situations on the T1212 applies to the person (such as rrsp, child support, etc) then they can get the amount of tax held at source reduced regardless if they have owed money in April in the past three years.

10 Felix

Hello Mike,

Great post, I’m interested in this too but a little bit concerned with the proof that you need to send in along with the form.

What sort of proof do I need to show for making a lump sum deduction for a certain year to a self-directed RRSP account. (I’m planning to use Questrade)

11 Four Pillars

Hi Felix – I’m not sure what you mean by proof. I assume you are talking about reducing the withholding tax on your salary?

I’ve never done it myself but I doubt you need any proof of anything (like a contribution receipt) – I would think you just fill out the form and send it in.

Ultimately the withholding tax from your paycheques is just an estimate and when you file your taxes, you will pay or get back the difference.

Mike

12 Felix

Well the form and from http://www.efficientmarket.ca/article/Reduce-Tax-Withheld,

it mentions that you would have to have some sort of proof that shows you are contributing periodically ( monthly) or one lump sum at some point of the tax year to an RRSP account to get your taxes reduced from source.

Since the way to fund your Questrade RRSP would be to receive your pay from your employer – a portion tax free, and move a lump sum or a periodically a portion, to the RRSP account, it would be great that the only proof you need is some sort of indication of that process.

Another concern is whether it is a huge concern for you to not deduct the entire amount you indicate on your T1213 (if you put down a lot say 18% of your previous year’s income), when you file your tax for the current year ( say you just want to deduct 10% of your previous income ).

13 Four Pillars

Hi Felix – I would check the government website and see what it says – the link you mention is a good site but it’s not a gov’t source. You can give them a phone call as well.

If you end up not contributing as much as you planned then you might have to owe the taxes when you file – this really depends on your individual situation. I don’t think it will matter too much to the government since they will still get their taxes but if you do this every year then they might deny the deduction of tax at the source in the future.

Mike

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