August 1998

Right Refund Strategy Increases
RRSP 30 to 50% or More, Part 2

© Talbot Stevens

This is a continuation of last month's Strategy Sheet that introduced the importance of different RRSP Refund Strategies. In the first two, the refund is spent, or reinvested back into the RRSP. Three even better Refund Strategies are identified below.

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 to immediately 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.

Her after-tax retirement commitment is now 50% of $2,000 or the same $1,000 commitment as the unregistered approach. To continue the race analogy, Sue is no longer starting behind the non-registered approach, and since RRSPs are the fastest vehicle due to tax-free growth, she is now guaranteed to win at producing the most retirement income. This is true as long as no one changes the rules, and penalizes some vehicles more than others, as was done in the proposed Seniors Benefit legislation.

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 max their RRSP, need to reinvest their refund somehow, 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 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.

Results of my latest research into the after-tax retirement income from registered and non-registered approaches will be shared in a future Strategy Sheet.

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