With the March 3 RRSP deadline fast approaching, you may be wondering whether you should join the herd and make that RRSP contribution in time to be able to claim the deduction on your 2013 tax return.
Whether or not you decide to contribute to an RRSP this year depends on a number of factors, the primary one being whether or not you have the financial ability, within your current budget, to set aside some of your 2013 income for future use. After all, isn’t that what saving, in an RRSP or any other vehicle, is really all about?
Assuming that you get over this hurdle and decide to forgo spending 100% of your current after-tax income on various goods and services today, is the RRSP truly the best vehicle in which to do so?
Not necessarily. Your ideal savings vehicle will depend on your financial goal, time horizon and current vs. projected future tax rates.
For example, let’s say one of your financial goals is to set aside some money each year to fund your children’s post-secondary education. If that’s the case, you may decide to contribute $2,500 of after-tax funds to a Registered Education Savings Plan for your child so as to generate an automatic 20% return, courtesy of the Canada Education Savings Grant. With an RESP, you don’t get a tax deduction for the amount of your contribution but the funds grow tax-deferred inside the plan. Ultimately, the contributions come out tax-free while the growth and the grants are taxable to the student when withdrawn, who likely won’t even pay tax given the various tax credits (basic, tuition, education and textbook) available to her.
If you have a mortgage, perhaps making an extra lump-sum payment to reduce the principal outstanding is the best use of any extra funds this year. An easy check is to compare the interest rate on your mortgage to the expected rate of return on your proposed investment. For example, if your five-year mortgage has a rate of 3.5% and you are an ultra-conservative, risk averse investor who invests exclusively in GICs, it may be best to channel any extra funds to paying down your mortgage since you’ll be hard pressed to find a no-risk investment with a guaranteed return higher than that over a five year period.
Finally, keep in mind that RRSPs aren’t the only game in town anymore with the introduction of the Tax Free Savings Account, which may prove to be a better choice for younger Canadians or those in the lowest tax bracket. Unlike an RRSP, when you contribute to a TSFA, you don’t get a tax deduction so you effectively are contributing after-tax earnings into the plan. This, however, may be a good thing if you are in a low tax bracket right now but expect to be in a higher tax bracket when you withdraw the funds. In this case, you will actually come out ahead of the game by avoiding an RRSP contribution. And as an added bonus, there is no TFSA deadline.