RRSPs are seen as mostly benefiting people saving for retirement. But they can also be put to good use by adults in their prime working years. Whereas retirees are limited to deferring taxes, younger persons can use RRSPs to achieve tax reductions and to facilitate buying a house or attending an institution of higher learning.
RRSPs can lower taxes for adults in the workforce if they are planning on taking a break from work for personal reasons, such as to start a business, have a baby, travel or write a book. While in the work force, contributions are made and tax refunds claimed. When the RRSP annuitant leaves work, withdrawals are made from the RRSP at lower tax brackets—thus turning the RRSP into an income-smoothing tool for the purposes of tax reduction. This feature is also handy for the self-employed or other persons with variable income.
A young couple may also save on taxes by setting up a spousal RRSP for the lower income spouse. Once in place, the higher income person can make contributions up to their contribution limit and claim the tax refund. After three years, the rules allow the lower income spouse to make withdrawals from the spousal RRSP at their tax rate—thus effectively splitting income and reducing household taxes.
Just be sure to start withdrawals at least three calendar years after contributions are made. In other words, the three-year period doesn’t start ticking away until after the end of the calendar year in which the last contribution was made. So try to make contributions by the end of the tax year (Dec. 31).
When withdrawing money from RRSPs, tax is withheld at source—and the tax rate rises with the size of the withdrawal. Rather than take a large lump sum from one plan, it should be broken up and removed in smaller chunks over time from more than one plan (if possible). This way, the RRSP holder may be able to get more of their RRSP funds right away, rather than having to wait until the next tax-filing period to submit a rebate claim.
Buying a house
Under the Home Buyers’ Plan, a couple buying their first house are permitted to withdraw $25,000 each from their RRSPs for a downpayment, then are asked to pay it back into the plan over the next 15 years. The tax refund gives couples another $12,500 to $20,000 to put down on a home purchase, making it easier to get the house of their dreams, lower mortgage payments, or avoid paying CMHC mortgage insurance fees.
If there isn’t much money in RRSPs to begin with, many couples with contribution room find ways to scrape up the money (for example, a zero- or low-rate loan from a relative). They then pass it through the RRSP to qualify for the tax refund and make a bigger downpayment. The contributions have to be in the RRSP for at least 90 days.
Under the Lifelong Learning Plan, people can similarly borrow from an RRSP to fund studies at a qualified educational institution for themselves or their spouse. However, as the plan comes with some restrictions, as well as a repayment schedule, some may find it easier to just withdraw the funds directly from their RRSP.
RRSP aren’t just for retirement. They can be used for other purposes prior to retirement. Indeed, these more immediate benefits may ultimately prove to be more valuable than the tax deferral obtained from saving for retirement should pressures on fiscally strapped governments result in higher tax rates and reduced retirement benefits in the years ahead.