Student/Low Income RRSP Strategy

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Student/Low Income RRSP Strategy

Post  Max on Thu Jul 01, 2010 9:32 pm

Normal RRSP strategy gets a tax deduction up front in exchange for converting all contributions and income to fully taxable status upon withdrawl. The aim is to have the compounding of the initial tax refund add up to more than the increased tax efficiency of investing outside of the RRSP in capital gains and dividends. Capital gains are essentially tax free compounding too (although not as flexible).

SCENARIO
You must have RRSP contribution room saved up, and expect to earn very little income in the current year, but expect to earn a good income at some point in the future. This could be useful for students with part time jobs, or for the temporarily unemployed.

METHOD
For a person with RRSP contribution room built up, but no income expected in the current year, it might be a good idea to max out their RRSP contribution and then withdraw it within the same year, in order to carry forward the RRSP tax deduction to a future year when they will be earning more income. This will withdraw the income at the lowest possible income tax bracket and leave the deduction available to claim at the highest possible tax bracket; all while leaving the original principal outside of the RRSP. As close to free money as I can think of.

Don't have a temporary $10,000 to max out your RRSP contributions all at once? No problem. This strategy would effectively allow you to contribute $500 and withdraw the same amount 20 x during the year in order to build up the credits. Therefore, you could use $500 to generate more than $500 in income tax credits and still be left with the original $500 outside of your RRSP (free to repay to whomever you borrowed it from).

POTENTIAL ISSUES
-There will be a 15% withholding tax which will not be recoverable until you file your tax return. There may also be fees and commissions on the investments, which may make it inefficient to reinvest in this way. A one-time contribution/withdrawl would be best, but still you will not fully recover the initial investment until the tax return is filed.

-This will use up RRSP contribution room permanently, which means you will miss out on "the miracle of tax-free compounding" as my tax teacher called it. But without the initial tax refund, which in this scenario, you will get regardless of whether you keep the RRSPs or sell them as I have suggested, the decision of investing inside or outside of RRSPs is in my opinion very much in favour of investing outside RRSPs.

Max
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