An RRSP strategy – The “gross-up”July 16th, 2018
A short-term boost for a long-term gain
What if you could increase your RRSP contribution with a loan that could be paid off before the first payment is due?
The lenders that Transamerica partners with for RRSP loans – B2B Trust and AGF Trust – both have options to defer your first payment on an RRSP loan for up to 180 days. And the RRSP loan programs offered through Transamerica’s lending partners allow you to pay off the loan at any time without penalty.
According to Statistics Canada, at the end of 2009 there was more than $600 billion of unused RRSP contribution room. Some of that room may be yours to claim. Of course, it’s not easy coming up with that lump sum every year, and if your cash flow is already tight, increasing your monthly contributions may not be an option.(1)
What is the RRSP “gross-up“?
The RRSP gross-up is a strategy that can be used to increase your RRSP contribution by taking out a short term RRSP loan and paying it back before the monthly payments are scheduled to begin. If you select an RRSP loan with the option to defer payments, you should have sufficient time to receive your tax refund and apply it against the loan before your first payment is due.
Five keys for the strategy to be implemented successfully are:
- A portion of the RRSP contribution must not be borrowed money.
- The expected tax refund should be the same as the amount borrowed (not including interest).
- The tax refund must be used immediately to pay off the RRSP loan.
- There must not be any outstanding personal tax liabilities.*
Any Home Buyer’s Plan or Life-Long Learning Plan repayments must be considered separately from the strategy, as they will not generate a tax refund.
*This strategy should only be implemented after consulting a tax specialist. Everyone’s situation is unique, and there are many things to consider before borrowing money, even with regards to your RRSP.
How much is enough?
Before you take your loan, you will need an idea of how much you should borrow to ensure that the amount of your refund is close to the amount owed. There will likely be some interest due when you pay off the loan which is not accounted for in the gross-up calculation. If you repay the full amount of the loan quickly, however, the amount of accrued interest should be minimal. Below is the calculation to determine the gross-up amount, that is, how much to borrow, to generate a refund close to the amount of the RRSP loan.
The gross-up calculation
(RRSP Contribution x Marginal Tax Rate) ÷ (1 – Marginal Tax Rate) = RRSP Loan
Marginal Tax Rate (MTR)
Your MTR is the amount of tax you pay on the last dollar earned. For help figuring out what your MTR is, visit www.cra.gc.ca or speak with your advisor.
RRSP tax refund options
- Jim has no outstanding tax liabilities.
- His sole income is his salary of $80,000.
- Marginal Tax Rate (MTR): 40%.
- Available RRSP contribution room (deduction limit): $35,000.
- Available cash to contribute from his savings account: $10,000.
As you can see, the RRSP gross-up strategy leaves Jim with a total of $16,667 in his RRSP, starting with the same $10,000 that he had in the other scenarios. In other words, his contribution is 67% higher than if he had not borrowed. It is important for Jim to file his taxes right away and pay off the loan to limit the accrual of interest. Provided Jim’s loan may be repaid at any time without penalty and permits deferred payments, he should be able to pay off most of the loan as soon as he receives his refund, without penalty and without making a monthly payment.
The RRSP loan must be taken within the intended year’s RRSP contribution period. Jim will have to make sure his full contribution is made prior to the RRSP deadline. Taxpayers are permitted to make RRSP contributions within the first 60 days of a given year to apply against the previous year’s income. Jim’s situation is for illustration purposes only. Everyone’s tax situation is different, and you should consult a tax specialist before implementing the gross-up strategy.
As always, be sure to consult your advisor before making any investment decisions.