Not All RRSP Contributions Are Alike

pet-financing

It’s that time of the year again where we all should start thinking about making contributions to our registered accounts for long term investment. In Canada that means taking advantage of the TFSA and the RRSP. For our Amerifriends that means thinking about taking advantage of your Roth IRA accounts or your 401k’s.

Like all registered accounts, there are varying limits to how much can be put into your accounts. Roth and TFSA accounts have a $5500 limit. The RRSP has a limit of 18% of your previous year’s income up to $24,270 for 2015. In the US the limit for 401Ks is $18,000. Either way it’s a good idea to sock away some money for the future. Unlike our friends with defined pension benefits, most of us have to save our way to a million.

Contributing to these accounts is generally quite easy. You can either walk into an actual bank and talk to a financial advisor, who will gladly do the deposit on your behalf, or you can do a transfer of money from your chequing account directly into one of your registered accounts through an online interface.

I’ll cover the Canadian aspects of making an investment, but similar rules would also apply to those in America, which I highly advise to look up.

Making Cash Contributions

Cash contributions are the easiest. All you have to do is pick an amount and transfer it into your registered account. The bank will take care of all the paperwork necessary to notify the government of your contribution. Unfortunately, this notification doesn’t happen until tax time (March or April), so if you’re in Canada, your CRA profile won’t update until April.

If you are using cash to invest, then life is easy. If you are managing your own investments, then follow the re-balancing rules to buy the proper asset type that follows your investment goals. For many people, this is probably what they will be doing.

Making Contributions In-Kind

This is where things get a little tricky. Some of us may have investments outside of our registered accounts that we want to move into our registered accounts. Almost all financial institutions will allow you to transfer your holdings from one account to another, but there are some things you should be aware of.

Transferring assets that you own in-kind will generate capital gains. This means that when you move an asset that you own that has gained money over time, that gain will now become taxed.

This isn’t the worse news to have. You’re still making money. The taxes you pay will be on your marginal income tax rate, but only half the gain will get taxed. Additionally, since you may be making a contribution to your RRSP, the gains will most likely get wiped out with your contribution.

On the other hand, if the assets you are transferring have actually gone down in value, making a contribution in-kind will mean that you will lose the capital loss write-off that you would otherwise be able to claim on later gains. Why does this happen? Quite simple. When you make a contribution in-kind, you are essentially selling it in a non-registered account and buying it back in the registered. Selling in a non-registered account triggers capital losses. However, since you end up buying back the asset immediately in the registered account, the CRA rule called, “superficial loss” kicks in.

A superficial loss occurs when you sell an asset and then buy it back within 30 days to try to claim a tax loss. The government cracked down on this behaviour so that people don’t do this at the end of the year just to claim losses on future gains. Since in-kind transfers are immediate and don’t follow the 30-day rule you do not get to claim capital losses.

Selling and Buying

calculatorIf you have losses in assets that you want to claim as a capital loss, then one strategy to employ is to sell the asset, but don’t buy the exact same thing. Buy something that is equivalent to what you sold to maintain the same kind of portfolio that you had.

The Canadian Couch Potato site outlines many different portfolio models that are equivalent to each other. It’s very easy to find low cost alternatives to funds you already own and this will help you keep your capital losses and portfolio make up still intact. This type of strategy that I just described is called tax-loss harvesting. Many robo-investing firms attempt this maneuver for you at the end of the year to try to minimize taxation on your investments. However, this might be overkill for most people because the transaction costs might outweigh any benefit. Tax-loss harvesting is something you should consider if you have a significant amount of money invested where the taxes can make a large impact.

Another approach to take is if you want to switch from mutual funds to ETFs because you feel your portfolio would benefit from lower management fees. Now could be the perfect time to sell your mutual funds and rebalance into ETFs that fit more into your investment goals.

Spousal Contributions

Many couples keep their RRSP accounts separate. Heck, if it’s till death do us part, then you might as well take advantage of the tax breaks that are given with a spousal RRSP. Yes, that means sharing, because sharing is caring and we’re all the better for it.

RRSP accounts are a tax deferral strategy. We all want to be equals, but the fact remains if you want to get the most out of an RRSP account then the person with the higher income should be claiming the contributions. It doesn’t mean that the other person is inferior and shouldn’t enjoy a retirement, it just means that more taxes will be given back to you and there is a greater chance that on withdrawal you’ll be in a lower tax bracket. Stop making it a competition people!

What’s more interesting with a spousal account versus a separate RRSP account is that you can actually income split it. Well sort of. After money has been in a joint account for 3 years, the other person can take it out. This is extremely effective for stay at home moms or dads, or for those other circumstances when a parent goes on mat leave without pay, or decides to go back to school.

Just imagine that the greater earner deposits money into a spousal RRSP and receives nearly 40% back in taxes. 3 years later the person that’s not working withdraws $20,000 completely tax free. This happens because the unemployed individual won’t even make the minimum income threshold for taxes. How’s that for a 40% return!

When it comes to money and retirement, a lot of couples don’t want to communicate with each other about it. That happens because money is more taboo than sex. We’ll ask for sex in a relationship, but we dare not talk about our finances. The smart thing to do is to include your significant other in the conversation. You’ll never realize how better off your finances will be with a little bit of careful, co-operative planning.

Don’t Delay

wristwatchThe RRSP deadline looms near for Canadians. There’s only about 2 weeks left, till February 29, to make the contribution. Let’s hope Christmas and New Year’s hasn’t drained your finances to prevent you from contributing to your RRSPs or TFSAs. If you’ve already planned and contributed, then good for you. You’re probably the 1% out there who actually thinks about their financial future rather than the next hot iPhone that is coming out.

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