Will more savings reduce your taxes?

The RRSP, the foundation for savings

Sixty years after its creation, the Registered Retirement Savings Plan (RRSP) has been adopted by more than 6 million Canadians as a vehicle to grow their money while paying less in taxes. Essentially, the money invested through this account isn’t taxed until it’s withdrawn, at an age when the beneficiary is in a lower tax bracket, because they have a lower income.

“Opening an RRSP is like setting aside some of your salary for later, and paying only a fraction of the taxes you would have owed at the time you made your contributions,” explains Judith Poirier, Assistant Vice-President of the Investment division at National Bank. “What’s more, unlike a retirement pension fund that’s paid out a little bit at a time, with an RRSP you can decide how much you want to withdraw. Which is great if you’re planning a sabbatical, for example!”

How can you optimize it?

• Take advantage of your spousal status. The partner who earns more can make withdrawals from their RRSP in their spouse’s name. Because tax rates are progressive, this strategy can allow you to minimize your household tax bill.

• Invest your tax refund wisely. “You need to keep in mind that the tax refund you get from contributing to your RRSP isn’t entirely free money, because at least part of that will need to be paid back when you retire,” says Judith Poirier. “Your best bet is to invest it somewhere that it will grow, or use it to pay off a debt. Spending it on travel for example, will pay off less.”

• Plan your RRSP withdrawals. Because RRSP withdrawals factor into the calculation of your taxable income, it makes more sense to spread them out in such a way that they don’t skyrocket your income, which could lead you to owe more tax and lose access to potential social benefits.

The TSFA, zero tax deductions

Initially created for low-income individuals, the Tax-Free Savings Account is gaining popularity among all savers, attracted by its flexibility.

“The TSFA is a bit like the nest egg hidden away in your home,” Judith Poirier kids. “You can invest and withdraw whenever you want, without paying tax. I particularly recommend it to people with lower incomes, because it doesn’t impinge on their access to social benefits.”

How can you optimize it?

• Remember that small savings add up. “I started investing the leftovers from my university bursaries and summer jobs into a TSFA when I was 22,” explains Kevan Saba, a consultant who is now 26. “It’s the most flexible financial vehicle for investing small amounts of savings without having to worry about taxes, ideal for students, for example.”

• Take advantage of your accumulated contribution room. The 2019 limit for TFSAs is $6,000. Since unused amounts accumulate year after year, you can contribute up to 63,500 into a TSFA in 2019. This tip is particularly useful if ever you receive a large sum of money, after the sale of a good or receiving an inheritance, for example, that you can invest in your TSFA and max out your remaining contribution space.

• Inject your RRSP return into a TSFA. High-income savers often prioritize the RRSP. However, you shouldn’t neglect to take advantage of the advantages of a TSFA, whatever your financial situation. “Those who have already maxed out their RRSP should consider investing their tax return in a TSFA,” says Judith Poirier. “It’s the best way to optimize it.”

RRSP, TSFA or both?

Judith Poirier and her colleague Chantal Lamothe, financial planning expert, developed a real-life situation to demonstrate the impact of an optimized savings plan.

Marie is 46 and has a net salary of $50,000 per year. She spends $36,000 on living expenses and invests $14,000 a year in a balanced fund, to fund her retirement which she hopes to take at age 63, in December 2034. She receives an inheritance of $25,000 and wonders what impact this money will have on her retirement.

Depending on how she invests that inheritance, Marie can either stop working earlier, at 62, or considerably improve her cost of living upon retirement.

Case 1: She deposits her $25,000 in a bank account. In December 2034, the anticipated date of her retirement, her inheritance has increased to $26,220.

Case 2: She deposits her $25,000 in a TSFA. In December 2034, her inheritance has grown to $44,248.

Case 3: She deposits her $25,000 in an RRSP, and her tax refund into an RRSP. In December 2034, her inheritance has grown to $57,424.

From case 1 to case 3, you can see that Marie’s inheritance grows at different rates, depending on the investment vehicle she chooses. Given her situation, Marie should definitely consider investing her inheritance in an RRSP and maximizing her profits by growing her tax return in a TSFA. In doing so, she’ll be able to retire about one year earlier, or increase her spending once she stops working.

The RESP, for forward-looking parents

The Registered Education Savings Plan (RESP) allows parents to invest up to $50,000 for their child’s post-secondary education. This contribution gives you the right to a 30% government subsidy. Once the student is enrolled in university, they can withdraw the amount of the subsidies as well as any interest. These withdrawals are taxable, but because the student usually doesn’t have much income, they will pay little or no tax. As for the contributor, they can recuperate their capital without any tax deductions.

“Currently, the RESP is the most lucrative account on the market,” says Judith Poirier. “If you have children, it’s the best savings strategy to adopt.”

How can you optimize it?

• Plan your RESP withdrawals. By spreading the withdrawals from your RESP over a long period, the student can be sure that they don’t surpass an annual income of $11,000, and avoid paying taxes.

• Create additional value between siblings. “If you have a child who’s already in CEGEP, you can withdraw money from their RESP to create a new one for a second child. They will then also receive the 30% in government subsidies,” explains Judith Poirier.

• Move unused contribution amounts into an RRSP. If a child doesn’t pursue a post-secondary education, withdrawing funds from their RESP incurs a penalty of 20%. Moving funds to a contributor’s RRSP, on the other hand, incurs no fees.

Beyond the financial strategy you can develop by comparing the advantages and constraints of the various investment options available on the market, the advice of a financial planner will help make sure you’re not missing out on any tricks that might maximize your profits. Don’t hesitate to share every element of your professional journey and your personal situation, because, you guessed it: in financial planning, even the little details can have a big impact!