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I am in a lower income bracket, however, like the idea of contributing to an RRSP because any earnings within the plan are tax-exempt.
Is it possible to contribute to my RRSP, but not have it deduct from my taxable earnings until I decide to do so? (Perhaps in a few years when I am in a higher tax bracket?)
Thank you!
Yes, you can contribute now, report the contributions on your 2015 tax return, but hold off claiming the deduction until a future year when it will make a bigger difference. However, by delaying the tax refund, there is an opportunity cost: the money you could get from claiming it in 2015 could be invested and allowed to grow, and could end up being worth more than the extra refund you would get a few years later.
Example:
Assume an Albertan earning under $40K has $1000 to invest. In 3 years he expects to be earning closer to $60K. He expects to retire on an income around $40K (in today's dollars). Let's also assume that however much he invests for retirement, it will increase 10-fold by the time he sells it.
If he chooses to put the investment in an RRSP account, he could get back $333 now and add it to the $1000, and end up retiring with a balance of $13333 before tax. After tax, assuming rates are similar to today, that comes to $10000.
If instead he waits 3 years to claim the contribution, he can get back $427 instead. But at the cost of missing out on 3 years worth of growth on the $333, which amounts to $439 using our assumed growth rate. So he's actually got $12 less after 3 years, and retires with $9929 after tax.
His third option is to invest the $1000 in a TFSA. There is no refund now, but the investment grows to $10000 and there is no tax on withdrawal. It is not a coincidence that this happens to be the same result as the first RRSP choice - the TFSA scenario will always match an RRSP when the person's tax rate at time of contribution is equal to the tax rate at time of withdrawal. The RRSP will win if you retire with a lower marginal tax rate.
So, for this example guy, which option should he choose? The TFSA. Because while it may produce equal results in terms of final value, when you withdraw from a RRSP it counts as income when determining how much OAS and GIS payments the government gives you - and the more income you have, the less free money they give you. So unless they change those welfare programs to consider total net worth or something, using the TFSA will ultimately result in more money for you in retirement. But this is only assuming you retire with the same marginal tax rate.
I'd also like to point out that a 10-fold increase would require fairly aggressive investments, which carry a lot of risk. If you are wise and shift toward safer investments as you approach retirement, that means achieving the 10-fold growth takes even riskier choices early on (such as the first 3 years). The deferred RRSP option is worth almost as much yet the only gamble is how long it will take for your income to increase into the next tax bracket. So the decision between the first two choices is actually more one of how much risk are you willing to take for a small increase? Personally I'd actually take the 2nd option if my TFSA was already maxed out, since TFSA is the best option in this example.
