Tuesday, June 16, 2015

Tax-Free Contributions to a Group RRSP are not a Special Tax Break

It’s common in high tech for employers to pay annual bonuses to most employees. Those who run a company’s group RRSP like to make an enticing offer: “transfer your bonus into your group RRSP TAX-FREE!” They make it sound like this is a special privilege where you’re getting some huge tax advantage, but this isn’t true.

To start with, any amount you transfer into your group RRSP counts against your RRSP limit, so be careful not to contribute too much.

The next thing to understand is that the only tax advantage of transferring a bonus to a group RRSP is the timing of your tax refund. Let’s look at an example. Suppose Alice and Ben are both in a 40% tax bracket and both get a $10,000 bonus. Alice puts hers in a personal RRSP account, and Ben contributes to his group RRSP.

Alice’s employer will deduct $4000 in taxes from her bonus and give her $6000. If Alice has another $4000 kicking around, she can make a $10,000 RRSP contribution and get her $4000 back as an income tax refund when she files her taxes next year.

In Ben’s case, the full $10,000 bonus goes into his group RRSP, but he will not get a tax refund for this when he files his taxes. Essentially, he got his refund right away because there were no payroll taxes taken off. His only advantage over Alice is that Alice had to wait to file her taxes to get her refund.

In the event that Alice didn’t have $4000 lying around, she could contribute only $6000, get a $2400 tax refund at the end of the year, contribute that to her RRSP to get a $960 refund the following year, and so on. This way she will eventually get $10,000 into her RRSP. In this case, Ben’s advantage is that he got the full $10,000 growing in his RRSP sooner than Alice did.

So, Ben got some advantage, but it has nothing to do with how much he ends up paying in taxes. Ben either gets his refund sooner than Alice, or he gets his money growing sooner than Alice. Some people get confused by all this and think that Ben is somehow saving $4000 more on his taxes than Alice is. This is not true.

Something else to consider is the investment choices available in the group RRSP. If Ben likes his investment choices and has the RRSP room available, then he might as well put his bonus in the group RRSP.

In my case, my group RRSP investment choices all have high fees. So, I do a direct transfer of my group RRSP assets to my personal RRSP every year. In my case, it makes no sense to put my bonus in the group RRSP.

Others in my situation who prefer a personal RRSP may think they’re missing out on a big tax break if they don’t put their bonuses into their group RRSP. Rest assured that you’ll eventually get the same tax break with a personal RRSP.

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