RRSP season is out in full force for Canadians and there’s just about 1 more week to go before the deadline. If you’ve been reading this blog you’ll know by now that the RRSP account has many uses. You’ll also know that the benefit of the RRSP is to defer taxes to a later date, so it’s much more advantageous to contribute when you’re making more money and will be taking it out at a lower tax bracket.
One of the more unknown secrets of the RRSP is how it actually affects your annual income and how you can get even more money back from the government if you have children.
Contributing To RRSP
When you contribute to your RRSP you are actually doing something that actually reduces your net income for the year. What this means is that by putting money into your RRSP account you are telling the government that you made less this year than you actually did. This is why you get a tax return back.
Let’s look at this example:
- Your employer pays you a salary of $65,000
- You decide to contribute 10% of your income into an RRSP account
By contributing $6,500 dollars you are effectively lowering your income for the year to $58,500. If you live in Ontario, the marginal tax rate at that bracket is 29.65%. This means you get back $1,927.25 in taxes because the tax you paid was for making $65,000 but by lowering your income you paid too much tax. This is why you got a refund.
The Canada Child Benefit
Ever since the Trudeau Liberal government came to power, the Canada Child Benefit has been boosted to aid Canadian families who have children in the household under 18 years of age. The benefit was designed to help lower income families more and thus as income levels rise the amount given by the government is lessened.
How deductions are calculated is based on the adjusted net income of the family. That means it combines the incomes of both spouses or the single parent. That’s where using an RRSP contribution can have it’s advantages. It can actually lower the net income of the family household because contributing to an RRSP effectively lowers your net income.
The child benefit is calculated in July but based on previous year’s net income. That means for people that are trying to maximize their benefits for this coming July you’ll want to lower your 2018 total income. So just how much do you have to go?
First off the benefits for children in July 2018 varied (all numbers will most likely be adjusted for 2019).
- $6,496 for each child under 6
- $5,481 for each child over 6 but under 18
In this scenario, a family of 4 with two kids under 6 are eligible for $12,992. That’s over $1,000 a month!
Now when families start making more money there are clawbacks from the government. In the example from above a family of 4 with 2 children under 6 making $65,000 total income would have $4,664.25 taken away. That would mean this family would only receive $8,327.75. That’s quite a significant reduction.
Now take into consideration that the family uses the RRSP to reduce their salary to $58,500. The amount reduced would now be $3,786.75 meaning the benefit will now rise to $9,205.25. That’s nearly a $900 gain.
So what does this all mean? It means that for every dollar contributed to an RRSP it’s possible to not just get tax back, but additional money that would otherwise be clawed back by the government from the Canada Child Benefit.
Is It Worth It?
You have to remember that the Canada Child Benefit was meant for lower income families, but that doesn’t mean it doesn’t help middle class families in Canada. The fact is if your income falls between $30,000 and $65,000 there is a good chance that you won’t even have the extra money to put into an RRSP.
The effects for higher income families are a lot lower because the percentage you get back is much smaller. It seems counter intuitive to think that richer people get less of a deduction per dollar earned, but that was just how the Liberal government created it.
For those that have low to middle income by contributing to an RRSP it’s almost like getting a 13.5% return on the money through the Canada Child Benefit. That’s actually quite a good return and not even the stock market could beat that.
So perhaps if you have children and you have some spare money lying around, using it to fill your RRSP might not be a bad idea.