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January 31, 2021

Five Tax Planning Strategies Using RRSP

Posted in   Retirement, Tax Planning   on  January 31, 2021 by  Admin , Comments:  0  

In Canada, the personal tax system is progressive so that the more you earn, the higher is your income tax rate. But have you wondered how it affects you and which tax planning strategies may be available to you?

Let’s consider an individual living in Ontario and earning annual salary of $97K. His tax liability on $97K would be around $22.4K for 2020. If he were to get a bonus of $2K in 2020, his taxable salary would increase to $99K and his tax liability to roughly $23.3K. As such, over 43% of his additional income of $2,000 is paid in taxes in 2020! The income tax bracket changes at $97,069 in 2020 ($98,040 in 2021) and, as a result, only a slight increase in taxable income can increase the marginal tax rate to 43.41%.

Effective tax planning involves managing your affairs in such a way that it decreases the overall tax liability by reducing your taxable income. One key tax planning tool is the Registered Retirement Savings Plan (RRSP). Essentially, RRSP is a retirement savings vehicle that allows you to defer taxes on contributions into RRSP until retirement. Income earned within RRSP also grows on a tax-deferred basis. Tax is applied when you withdraw funds from RRSP. RRSP can also be transferred into registered retirement income fund (RRIF) or an annuity when you turn 71. Most people are usually in a lower tax bracket after retirement; hence, the tax rate on retirement income is likely to be lower than what it would be now.

The following are some tax planning strategies using RRSPs.

1. Contributing into RRSP to Reduce Tax Liability

RRSP contributions are tax deductible - they can be claimed as a deduction from income in the same year or may be carried forward and claimed as a deduction in a future year, depending on your expected income level. In the example noted above, if RRSP contribution of $5,000 is made by March 1, 2021, it can result in tax savings of $2,000 for 2020. For effective tax planning, you must consider not only your income level but also the income sources during the year to calculate the optimal amount of RRSP contribution for that year.

2. Income Splitting through Spousal RRSP

Splitting income with the low-income spouse can reduce taxable income and marginal tax rate of the high-income spouse. Spousal RRSP lets you contribute into your spouse’s RRSP, so that income, upon retirement, is split between the spouses and your combined taxes are lower than what you alone would have paid if the entire amount were received by you.

You must consider the following with a spousal RRSP:

  • If you contribute into your spouse’s RRSP, you are the one who will claim this contribution as a reduction of your income in the same year or in a future year. This works out well if you were the high-income spouse.
  • Your RRSP deduction limit is reduced by your contribution into spousal RRSP. For example, if your RRSP deduction limit for 2020 is $15K and you put $6K into spousal RRSP, you have the balance of $9K to contribute into your RRSP or leave unused.
  • Your contribution into spousal RRSP must not be withdrawn for at least 3 years. If a withdrawal is made by the spouse within 3 years, it is added to your taxable income and not your spouse’s.
  • You cannot contribute into your RRSP after the end of the year in which you turn 71. But you can still use your RRSP deduction limit to contribute into spousal RRSP until your spouse turns 71. This is particularly useful in reducing overall taxes if you are over 71 and still earning and your spouse is in a lower income tax bracket.

3. Using RRSP as a First-Time Home Buyer

Withdrawals from RRSP are taxable in all cases except two. One of these exceptions is the Home Buyers' Plan (HBP) that allows you to withdraw tax-free funds of up to $35,000 from RRSP to buy a home for yourself or for a related person with a disability. This opens up an effective tax planning opportunity, whereby you reduce taxes in each of the years that you contribute into RRSP and then access the accumulated funds ahead of your retirement and without any immediate tax implication. You have up to 15 years to repay the amounts that you have withdrawn from your RRSP under the HBP.

Unless you are a person with a disability or you are helping a related person with a disability buy a home, you must be a first-time home buyer to withdraw funds under the HBP. A first-time home buyer does not mean that it is the first ever home that you are buying as a principal residence. Instead, you qualify if, at any time in the previous four years, you did not live in a home that you owned or that your current spouse or common-law partner owned.

4. Using RRSP for Post-Secondary Education

Another way to withdraw tax-free funds from RRSP is through the Lifelong Learning Plan (LLP) whereby you can take out up to $10,000 in a year, and up to $20,000 in total, for your or your spouse’s full-time technical or vocational training or post-secondary education. LLP can be used toward part-time education if the student has a disability. Repayments to RRSP under the LLP is done over a 10-year period.

Contributing into RRSP for subsequently withdrawing those funds under LLP can be an effective tax planning tool for individuals who are currently in a low-income bracket and are pursuing further studies. For example, if you are a college student with a part time job, you can contribute into RRSP but can decide to forego deduction from your taxable income in the current year since your marginal tax rate is already low. You can carry forward the un-deducted contribution and use it in a later year when your income level has gone up, while in the meantime having used the LLP to partially fund your education.

5. Final RRSP Contribution

The final RRSP contribution must be made up to December 31 of the year in which you turn 71, by which time RRSP must be either withdrawn or transferred into RRIF or an annuity. If you are working during the year when you are 71, you will have RRSP deduction limit for next year, but you will not be allowed to contribute into your RRSP at that time. A tax planning opportunity arises here - you can estimate your RRSP deduction limit for next year and make a final contribution into RRSP in December of the year in which you turn 71 before it is converted into RRIF or annuity. CRA will charge 1% penalty on the over-contribution for one month only, but you will potentially have a larger tax saving by deducting RRSP contribution from your income for next year.

Choose Wisely

Tax planning cannot follow a ‘one size fit all approach’. You need to be careful in deciding which tax planning strategy works best for you and choose the optimal combination that can help reduce taxes. The options that have been discussed here are meant for general information only, and you must obtain professional advice in deciding which tax planning strategy would work in your particular situation. 


We are a CPA firm in downtown Toronto that provides tax, accounting, corporate and advisory services to businesses. We would be happy to answer any questions that you may have.

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