Tuesday, March 27, 2012

Optimizing the Timing of RRSP Contributions

Most people who make RRSP contributions for the 2012 tax year will do so either with periodic payments throughout 2012 or at the last minute in February 2013. There are those who suggest that people should make their 2012 contributions right now to take maximum advantage of deferred taxation. I have my own approach, but I don’t necessarily suggest that others should follow my lead.

I agree with those who say that last-minute contributions are less than optimal. At the same time, I don’t like making a contribution until I’m certain that I’ll use the deduction the next time I file my income taxes. Consider the following potential sequence of events.

- I make a large RRSP contribution today.
- Tomorrow my boss decides he’s tired of me and fires me.
- I decide to drift into semi-retirement and never make a large income in any one year again.

RRSP contributions work best when they are deducted against income that is taxed at a high marginal rate. I haven’t made enough money yet this year to get into the higher tax rates. And I prefer not to make a contribution just assuming that I will have a high income in some future year.

So, my strategy is to wait until I’ve earned enough this year that I’d want to make an RRSP contribution even if I never made another cent until next year. The result is that I tend to make my RRSP contributions in the spring or summer. Then I fill out a T1213 form to get my payroll taxes lowered for the rest of the year.

Much of my financial decision-making takes into account very negative possible outcomes. Some may say that it’s not worth delaying an RRSP contribution for fear of being fired, but I consider a few-month delay to be a very minor cost to protect against the case where I lose my job after I make an RRSP contribution I wish I hadn’t made.

This line of reasoning works for me in my circumstances, but I doubt that it applies to many other people.


  1. If you made an RRSP contribution now, got fired, and semi-retired, I don't see much of a problem (aside from losing your job). You could immediately withdraw the contribution and apply the RRSP credit on your 2012 return, in which case the tax deduction would cancel out the RRSP income and you'd be back where you started. Assuming you're semi-retiring the wasted RRSP contribution room shouldn't matter too much. Or alternatively, you could defer both the withdrawal and application of the RRSP credit (since you can defer it indefinitely) until a later time that's optimal for your personal situation, in order to take advantage of tax-free compounding.

  2. @Jason: I'll grant that the advantage of the way I handle this is thin, but you haven't convinced me to change. In your scenario, I'd lose the contribution room if I withdrew the money later in the year to live on. Then if I did have a later high income year, I wouldn't be able to get the tax benefit. I think a few months of delay in contributing each year is a very small price to pay to avoid a potential loss of contribution room that could be valuable later.

  3. I'm not so sure I see much of an disadvantage to contributing early, still. If you think there's a chance you'll have more high income years, then just defer the credit, since you can do so indefinitely. If you end up having more high income years, then it's win-win since you've taken advantage of tax-free compounding inside your RRSP. In this situation you're (usually) better off than if you had kept the money in a non-registered account since you'll defer paying taxes on the investment income.

    This of course doesn't apply if you need the cash immediately to live off of after losing your job, in which case you might have no choice but to withdraw from your RRSP and lose the contribution room. But I'm guessing that's not the case for you.

    You're right that the benefit to contributing a few months early is minimal, however.

  4. I like the way you think. This one reminds me of your advice for wealthy athletes for some reason.

  5. @Patrick: I see the parallel. Be aware of the worst outcomes and make a sensible choice.