Wednesday, July 4, 2012

Exploiting RRSP Tax Confusion

A while back I listened to a pitch designed to get employees at my company to sign up for a group RRSP plan. One of the points the salespeople made that resonated with the audience was that employees could have their entire bonus payment deposited into their RRSP accounts without any withholding tax. Many employees were left with the false impression that this would save them a bundle on their taxes.

To make this more concrete, suppose that employee Megan receives a $20,000 bonus and has a 45% marginal tax rate. Megan will only get to keep $11,000 of her bonus. But if she signs up for this group RRSP, she can deposit the entire $20,000 into her RRSP. It seems like she is able to save $9000.

A first objection to this naive analysis is that Megan could have put the $11,000 after-tax bonus into an RRSP and would later get back $4950. So, Megan only saves $4050 with the group RRSP. However, even this analysis is flawed.

Suppose that Megan has $9000 in other savings. She could use that money plus her after-tax bonus to make a $20,000 RRSP contribution and then get a $9000 tax refund when she files her taxes for the year. This makes it clear that the main benefit of the group RRSP plan is that Megan essentially gets her tax refund right away instead of having to wait until she files her taxes. If Megan doesn’t have $9000 kicking around, then she can borrow the money and pay off the loan when she files her taxes.

Another twist is that Megan could file a T1213 form with CRA so that she would get her $9000 back spread over her remaining pay cheques for the year instead of waiting until tax-filing season.

In the end, the group RRSP doesn’t save Megan $9000. It just saves her a little interest on this amount and saves her some aggravation.

13 comments:

  1. Although just to note for any readers who haven't done the T1213 before, don't expect it to be done in a couple of weeks before year end or anything like that.
    Generally it's always seemed to take a generous 2 months for me to get the approval letter back, at least from my local tax office.

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  2. @Daryn,

    It sounds like your experience has been worse than mine. I haven't exactly been happy with the response time to my T1213 forms, but I've had responses within a month.

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  3. I'm sure that work RRSP P.Plan also has a very attractive MER/IMF of around 2.5% to further destroy your contribution in a segregated fund going nowhere slowly.

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  4. @Paul: You're not too far off. The MERs range from 1.5% to 2%. This is better than some, but still painfully high.

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  5. This isn't unique to group plans. The company I work for will also do this when requested. They cut a cheque for your bonus (the full amount) payable to to your personal RRSP account at your bank. You hand deliver the cheque for deposit into your RRSP account.

    Of course, you don't get a refund for that RRSP contribution, as you used Pre-Tax dollars to make the deposit

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  6. @Paul T: I've never worked for an employer that offered this service, but it makes a lot of sense.

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  7. I think you meant she could use her savings to make a $29,000 contribution?

    One question: would this idea mean chewing up an additional $9k of contribution room? Does the direct pre-tax contribution save her $9k of room?

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  8. This comment has been removed by the author.

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  9. @Patrick: Perhaps I didn't explain things clearly enough, but I meant that she would use her $9000 in existing savings plus the after-tax bonus amount of $11,000 to make a $20,000 RRSP contribution.

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  10. @Michael: It's much the same as asking for less taxes to be taken out of your regluar pay because you regularly make RRSP tax contributions. IE: you don't want to give the government a free loan while you wait to file your yearly taxes and get a big refund back.

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  11. What if you had $20,000 saved off the grid... Wanted to put it into your rrsp and get the tax benefit year end and then use the $20,000 as a deposit for a first time home buyer ?? Possible ? Ideas how to make $20,000 benefit me thru rrsp?

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  12. @Joe: I'm not sure what you mean by "off the grid", but assuming you just mean $20,000 in non-registered savings, then what you suggest is possible -- you just have to watch out for the rules that require a delay from the last RRSP contribution to the first-time home-buyer's plan withdrawal. This required delay time has changed at least once over the years. I'd suggest looking at the CRA web page for the home-buyer's plan.

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  13. So I have 20,000 in savings. If I put it into rrsp's.... Will I get some return come tax time?

    Then after the money has made money for me... I can use it as a downpayment on a home - tax free... Then put that value back at 1/15th per Annum...

    If you had 20,000 / had rrsp's / wanted to buy a house - what would you do?

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