With the 2011 RRSP contribution deadline fast approaching, we thought it would be timely to remind people that an RRSP deduction is discretionary. In other words, a taxpayer can deduct from 0% to 100% of an RRSP contribution in any given taxation year. Any undeducted RRSP contribution can be carried forward to be deducted in a future year.
The timing of the RRSP deduction can result in significant tax savings (or loss if the timing is not optimal). For example, if a taxpayer is currently in a lower tax bracket then they expect to be in a future year, they could make their RRSP contribution (to begin the tax-free compounding) but defer the deduction until a later year when they are in a higher tax bracket.
For example, a university student may be in a low tax bracket and/or have tuition credits to eliminate tax in the current year. If the student has sufficient earned income or RRSP room, she could make an RRSP contribution but defer the deduction to a post university year when she may be in a higher tax bracket. If she can utilize the deduction at the highest marginal tax rate, she can save 46%, compared to, say, 20% if she used the deduction at the lowest marginal tax rate. This 26% after-tax savings is significant.
If finances do not allow the taxpayer to fund the RRSP contribution, they may consider a loan from a family member or a bank. The pros and cons of borrowing to make an RRSP contribution are beyond the scope of this tax tip.
Readers are reminded that it is better to make an RRSP contribution early in the year instead of waiting for the deadline. The earlier the contribution is made, the earlier the benefits of tax free compounding begin. Many people may be focused on meeting the February 29, 2012 deadline for a contribution to be deducted in 2011. By that date they will already be 60 days late for making their 2012 contribution.
If finances permit, it may be worthwhile to make both the 2011 and 2012 RRSP contributions at the same time.
See Tax Tip 09-20 to learn how to request a reduction in source deductions as this may help a person fund their accelerated contributions.
TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.