The mathematical approach to RRSP contributions

The Income Tax Act allows you to contribute up to 60 days after the end of the year to your RRSP.

For the 2018 tax year, the last day to contribute is Friday, March 1. This 60-day buffer gives you ample time to estimate your taxable income and determine if it makes sense to make a contribution.

Assuming it makes sense, the next step would be to look up your 2018 RRSP Deduction Limit. This can be obtained either by looking at your previous year’s Income Tax Notice of Assessment. Within this notice you should see a table that is titled “2018 RRSP Deduction Limit Statement.” This table provides your RRSP deduction limit for 2018 and will note the dollar amount of any unused RRSP contributions. If you have unused RRSP contributions, this amount must be subtracted from the RRSP deduction limit to obtain a net amount. Unused RRSP contributions are amounts that you contributed in past years but have not yet claimed.

To illustrate, your statement could show $26,480 on the RRSP deduction limit line. On another line it may show $12,100 of unused RRSP contributions. In this situation, the maximum you would be able to contribute, and be able to claim as a deduction, is the net amount of $14,380. CRA does permit individuals to contribute $2,000 over and above this net amount without being subject to the one per cent per month over contribution penalty.

Now you have estimated your taxable income and you know the maximum net amount to contribute.

In next week’s column, we have listed 50 questions people should ask themselves before jumping directly in. It is still early in February and you have lots of time to still make an informed decision.

Perhaps one of the more simplistic approaches is to estimate the tax savings if an RRSP contribution is made. Reviewing both the federal and provincial marginal tax brackets is the starting point.

Federal tax rates for 2018

• 15 per cent on the first $46,605 of taxable income, +

• 20.5 per cent on the next $46,603 of taxable income (on the portion of taxable income over 46,605 up to $93,208), +

• 26 per cent on the next $51,281 of taxable income (on the portion of taxable income over $93,208 up to $144,489), +

• 29 per cent on the next $61,353 of taxable income (on the portion of taxable income over $144,489 up to $205,842), +

• 33 per cent of taxable income over $205,842

B.C. tax rates for 2018

• 5.06 per cent on the first $39,676 of taxable income, +

• 7.7 per cent on the next $39,677, +

• 10.5 per cent on the next $11,754, +

• 12.29 per cent on the next $19,523, +

• 14.7 per cent on the next $39,370, +

• 16.8 per cent on the amount over $150,000

This math-oriented approach can be simplified through many online RRSP calculators. The estimates below are from https://www.ey.com/ca/en/services/tax/tax-calculators-2018-personal-tax

Taxable Income

Taxable income before RRSP contribution Taxes payable before RRSP RRSP contribution Taxes payable after RRSP Taxes savings difference ($) Taxes payable difference (%)
$10,000 $0 $10,000 $0 $0 00.00%
$20,000 $1,256 $10,000 $0 $1,256 12.56%
$40,000 $5,734 $10,000 $3,618 $2,116 21.16%
$80,000 $16,669 $10,000 $13,831 $2,838 28.38%
$120,000 $31,285 $10,000 $27,230 $4,055 40.55%
$160,000 $48,241 $10,000 $43,661 $4,580 45.80%
$200,000 $66,561 $10,000 $61,981 $4,580 45.80%
$240,000 $86,247 $10,000 $81,267 $4,980 49.80%

No Taxable Income

For individuals with no taxable income, we do not recommend contributing to an RRSP as there are no tax savings. If a child or individual has earned income and they are under the basic exemption it may still be beneficial to file a tax return. Filing a return will report the earned income, 18 per cent of which will be used to build up RRSP contribution room for the future. One day when the individual has higher taxable income they will also have RRSP room they can take advantage of.

Lowest Marginal Rates

Individuals who are in the lower marginal tax bracket but are expecting a significant increase in salary next year may be better off delaying their RRSP contribution. If an RRSP contribution is made then the individual may be better off not claiming the deduction and carrying forward the unused portion to the subsequent years when it is more advantageous. If your income is below the top of the first provincial tax bracket (2018 this is $39,676) you should look at all the non-mathematical components of the RRSP decision.

Highest Marginal Rates

Those in the highest marginal tax brackets may benefit the most from RRSP contributions. Canadian taxpayers have few ways to lower their taxable income — an RRSP contribution is one. As illustrated above, individuals in the 49.8 per cent marginal tax bracket may reduce taxes payable by about 50 per cent of the amount they contribute. In addition to the tax deduction any potential growth within the RRSP compounds on a tax-deferred basis until the funds are taken out as a withdrawal (hopefully in a lower tax bracket in retirement). If you are in the highest marginal tax bracket, with taxable income over $205,842, we normally recommend contributing to an RRSP from a mathematical perspective.

Many people are in the grey zone, with income above $39,676 and below $205,842. The mathematical approach is useful, but often is too simplistic. Next week we will outline 50 questions to help those in the grey zone determine if making an RRSP contribution is right for them.

Kevin Greenard CPA CA FMA CFP CIM is a portfolio manager and director of wealth management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week in the Times Colonist. Call 250.389.2138. greenardgroup.com