Increase your RRSP income by 30%-to-50%

Reinvesting your RRSP refund boosts the after-tax value of your RRSP

If you want to get the best return from your investment dollar, it is essential to evaluate investment strategies in terms of their ability to produce after-tax income over the desired time period.

To illustrate, let's say that Sue has $1,000 to invest and is in the 50% tax bracket. If Sue invests the $1,000 outside of RRSPs, she makes an after-tax commitment of $1,000 to her retirement goal. This is because we only own after-tax dollars, where income taxes have already been paid.

I have identified five distinct RRSP refund strategies, each producing different levels of retirement income.

1. Spend the refund. Unfortunately, the most common RRSP refund strategy is to spend it. The refund is spent, it produces absolutely no retirement benefit.

The $500 deduction reduces Sue's after-tax cost from $1,000 to $500. Therefore, if she spends the refund, Sue's after-tax commitment to her retirement goal is only $500.

2. Reinvest the refund. A disciplined investor, Sue knows that to get the most retirement benefit from her RRSP she must reinvest all of the refund back into the RRSP. Simply reinvesting the 30-to-50% tax refund increases your RRSP funds by the same 30%-to-50%.

By reinvesting the $500 refund, Sue's RRSP starts at $1,500. The after-tax value, if immediately cashed in, would be 50% of $1,500 or $750. The after-tax commitment to her retirement goals is therefore $750.

3. Gross up. Sue can borrow an extra $1,000 to `gross up' her RRSP contribution to $2,000. The $1,000 refund is used immediately to repay the $1,000 loan so she pays little, if any, interest. By `grossing up,' Sue gets the maximum RRSP dollars working for each dollar she has to invest.

The after-tax retirement commitment is now 50% of $2,000 or the same $1,000 commitment as the unregistered approach.

Note that the `grossed up' strategy results in no loan outstanding and is different than the following two strategies where a larger loan is paid off over one or more years.

4. Top up. Traditional RRSP loans are promoted to "top up" RRSPs to make the maximum annual contribution possible. If Sue's RRSP room for the year was $5,000 and she only had $1,000, she could borrow the extra $4,000. Her refund could pay off most, but not all, of the loan.

5. Catch up. In the last few years, some institutions have promoted larger RRSP loans that can be used to `catch up' all unused RRSP contribution room at once. This is an extension of the `top up' strategy, but the loan is paid off over several years.

The last two cases are a conservative form of leverage -- borrowing money to invest. While the interest expense is not deductible when you invest borrowed funds in an RRSP, you get a much larger RRSP growing earlier.

Choosing a better refund strategy doesn't just benefit those who don't maximize their RRSP every year. Even those who always top up their RRSP need to reinvest their refund, either into unregistered investments or by paying down personal debts. Otherwise, they could produce more after-tax retirement income by investing the same dollars outside of RRSPs. This is especially true for those closer to retirement or for those who invest in equity funds which grow mostly tax-deferred and are later taxed less.

If your investment priority is retirement, the RRSP refund must be put towards that goal. Reinvesting the refund or using an RRSP loan is a simple way to increase your RRSP income 30%- to 50% or more.

Talbot Stevens is a financial educator, speaker and author of Financial Freedom Without Sacrifice. Phone (519) 663-2252.

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