Dear Expert:
I am expecting a long-term incentive payoff next year ($100,000 or more). Is it a good idea to not contribute to my RRSP this year and next and put the incentive-payoff money directly into the RRSP instead of being taxed on it and pushed into a very high tax bracket? Can I carry over any amount for a cumulative time? Expert Answer:
The tax characterization of your "long-term incentive payoff" is not clear. If the amount is received on or after retirement in recognition of long-term service, or in respect of loss of employment, it is considered to be a retiring allowance. However, if your employment is continuing and the amount represents a type of bonus payment, it is characterized as employment income.
In either case, the amount you receive is taxable in the year received. However, the amount you can transfer to your RRSP will depend on whether the payment is considered to be employment income or a retiring allowance.
If the payment is a retiring allowance, the amount you can transfer to an RRSP is limited to $2,000 per year of service with the employer (or related employer) for years before 1996, plus $1,500 for each year of service before 1989 where employer contributions to a registered pension plan (RPP) or deferred profit sharing plan (DPSP) have not vested. So if, for example, you have been with your employer since 1985 and you are not a member of an employer pension plan, you would be able to transfer $28,000 ($2,000 x 11 + $1,500 x 4) to your RRSP. The only way that you would be able to transfer the full amount to your RRSP is if you had more than 35 years of service.
In addition, in order to benefit from the transfer, the contribution must be made within the year or 60 days after the end of the year that the retiring allowance is received; you cannot spread it over a number of years. This particular permitted transfer is above and beyond your regular RRSP contribution based on earned income. In fact, a retiring allowance is not considered earned income and therefore it does not provide you contribution room in excess of the amount eligible for transfer.
However, if the amount is considered to be employment income, it forms part of your earned income for purposes of your RRSP contribution-limit calculation. If you expect to receive the payment during 2005, it will affect your RRSP contribution in respect of the 2006 taxation year. The RRSP contribution limit for that year will be the lesser of $18,000 and 18% of earned income. In addition, any contribution room you have from prior years carries forward.
It is reasonable to consider not making your RRSP contribution for 2003 (I assume you mean the 2003 taxation year) and next year (2004) in order to claim the RRSP deduction in a future year when your marginal tax rate will be higher. The maximum additional contribution room that you can accumulate by not making RRSP contributions for 2003 and 2004 is $30,000.
Although I can't provide a specific answer in relation to the benefit of delaying RRSP contributions because I don't have your precise numbers, you will have to determine what the trade-off is between getting the benefit of the tax saving earlier and the greater tax saving as a result of using the deduction at a higher tax rate. For example, if you earn $60,000 annually, your marginal tax rate is about 33% and your annual RRSP contribution is limited to $10,800. The savings would be $3,564 over two years. If you hold off on making two years' worth of contributions and make the contribution when your marginal tax rate is 43% (this is the current marginal rate for $100,000 of income), your saving increases to $4,644. In this case you are likely better off claiming the deduction in the year with the higher marginal rate, since the time value of money will likely not provide you with the additional $1,080 over two years. You might want to try the calculation with your numbers to make the proper comparison.
A final note: You can make the contribution currently and claim the deduction in a future year. This way, you get the benefit of the tax-free compounding in the RRSP immediately and you can still claim the deduction in a future year, when it is more beneficial.
No statement in this article should be construed as a recommendation to buy or sell securities or to provide investment advice or individual financial planning. Morningstar Canada does not provide specific portfolio advice and recommends the use of a qualified financial planner when appropriate.
To find out how much an RRSP contribution may save you, try Morningstar's RRSP Calculator.
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No statement in this article should be construed as a recommendation to buy or sell securities or to provide investment advice or individual financial planning. Morningstar Canada does not provide specific portfolio advice and recommends the use of a qualified financial planner when appropriate.
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