Many Canadians know what RRSPs are because they’ve been around for a very long time. Most Canadians use the RRSP wrongly because they think they get a tax refund. Primarily the RRSP is used for retirement savings because quite simply the word “Retirement” is one of the words in the acronym RRSP. Despite the naming of the account, an RRSP doesn’t have to be used as a retirement savings account. I’ve mention numerous times that an RRSP is just an account that is used to defer taxes, not give it back to you. That’s the main point of the account. For that very purpose, there are many other ways you can take advantage of that aspect. Here are 5 other ways where your RRSP can be put to work for you:
First Time Home Buyers
One of the more popular rules allowed with an RRSP account is withdrawing the money for first time home buyers to use as a down-payment for the house. The amount of money allowed is $25 000 per person. If you and your spouse are buying a house together, that means you can have up to $50 000 to be used as a down-payment. The only caveat is that the money has to be put back into the RRSP over a 15 year period starting from the second year you own the house. Money has to be put back every year, otherwise you will be charged income tax for the portion of the money you don’t pay back. This is an option for those that have put all their savings in their RRSP to have it grow tax free.
Though up front it seems like a great idea, this doesn’t really work out as planned according to Stats Canada. Research has found that almost 50% of people who take advantage of the home buyers plan do not pay back to their RRSP. This means they are essentially getting taxed on the money they took out. I tend to believe if you have to dig into your retirement fund to buy a home, you shouldn’t be buying one at all. Those rare individuals that are diligent and budget accordingly can use the home buyers plan to their advantage.
Post Secondary Education
No investment is better than investing in yourself. If you plan on going back to school for post secondary education, the RRSP account can be used to withdraw money for your education under the Lifelong Learning Plan. Up to $20 000 can be withdrawn over a 4 year period with a maximum of $10 000 on any given year. The money can only be used for your own or a spouse’s education but you cannot do this for your children.
Repayment of this withdrawal from your RRSP needs to be paid back starting on the fifth year. 10% of the money needs to be repaid each year over a 10 year period to avoid getting taxed on the money you take out. The Lifelong Learning Plan is similar to the home buyers plan in that there is a set amount of time that you have to pay it back; however, it you are required to pay back the minimum 10%. If money is not put back into the RRSP to make up for the withdrawal, then there are taxes that will have to be paid.
Having a kid might be the most gratifying moment you may have. The only downside is a parent usually takes maternity leave to take care of the baby. This means that a full income is lost unless the company that the person works for provides full income replacement during maternity leave. For those that are not as fortunate, it’s actually possible to withdraw money from your RRSP during this period to supplement that lost income. Remember that an RRSP is a tax deferral. This is the perfect time to take advantage of it.
Maternity leave is temporary, but it will reduce your annual income. If the amount of money you are expecting to earn while on maternity leave will put you into a lower tax bracket than when you are working, then taking money out of your RRSP will be advantageous. What happens is that the tax rebate you received when contributing will be greater than the amount of tax you have to pay taking out the money from your RRSP. The difference between the two is your real tax refund. Now that you have the money out, it’s still possible to throw that into a TFSA account and have it grow tax free just like your RRSP.
Unfortunate circumstances can happen where you may lose your job. During these moments, it may be necessary to have to withdraw money from your RRSP account. The same rule applies to unemployment as it does with maternity leave. If you know that your income will be low, because of the lack of income, then taking some money out will mean that you will get taxed less.
Unemployment is trickier though because you may gain employment at any point during the year. It’s hard to gauge the benefit because you could receive a job that pays a significant salary, in which case, the taxes you pay taking out the money from the RRSP may not in fact be at a lower tax bracket. This strategy is only prudent if you know you will be unemployed for a significant amount of time and your annual income will be depleted.
One of the great things about getting married is the ability to split income. A very effective way of doing this is through the use of the RRSP. If there is a spouse that stays at home and doesn’t work, one way to shift the income is through a spousal RRSP. The contributor of the money to the RRSP can claim the deduction from income and after 3 years, the money sitting in the account can be withdrawn by the other person with very little taxation.
Since the second spouse doesn’t work, he or she can withdraw money from the spousal RRSP without paying any taxes at all if the amount is below the personal tax exemption. The only rule that applies to this scenario is that the money must be sitting in the account for 3 years before the spouse can withdraw it. This means you have to plan ahead of time, and it can’t be a spur of the moment thing. If money is taken out early, then the contributor will get taxed for the amount.
This is a great way for the other person to build a TFSA account based on RRSP contributions from their spouse. Using this strategy can mean that money can grow and compound with the absence of any taxes!