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Tag Archives: budgetting

I did some calculations on my previous impressions of whether I should claim my RRSPs this year, or save them to lower my tax bracket in the future. Now that I have some clear numbers, it seems worthwhile to save my contributions for the immediate future.

Based on 2007 figures tax rates, the federal tax bracket is ~$74k while the Ontario tax bracket is at ~$71k. For simplicity, let’s say that both tax brackets are at $73k. The federal tax rate moves from 22% to 26% while the Ontario rate moves from 9.15% to 11.16%. Overall, when you exceed the tax bracket, you pay an additional 6% more tax on the excess amount over the boundary. Let’s say I made $80k in 2007 and so had to pay an additional 6% on the extra $7k, or $420. To prevent this extra tax, I could use $7000 in RRSP contributions. So the question is, what would have been my opportunity cost for that $7k in RRSPs?

Regardless of when you claim the RRSP, you have to pay 22%+9.15% (let’s say 32%) tax on the $7k. If you claim the RRSP in the future, then you save the extra 6% ($420) tax you would have paid. However, if you claimed the RRSP in the past, you would end up with an extra 32% ($2240) to play with for a couple of years. Now, compound interest comes into play. If you delay a year, then you need to earn 18.75% interest in order to break even. A pretty unlikely goal, so delaying one year is worth it. The percentages work out to { 8.9%, 5.9%, 4.4%, 3.5% } for 2-5 years into the future.

From those numbers, it seems worth it to delay RRSP contributions by 2 years, 3 at the outset. Since the numbers are ratio based, it would work the same for $3000 or $15000 in contributions, although remember that it’s based on the assumption that you will exceed the (moving) tax bracket boundary by the equivalent of your saved contribution within 3 years. If your income is steady, then your rate of return on the open market will need to be much less in order to break even, so then it’s better than claim the RRSP benefit immediately (provided you’re not going to waste the money on candy).

Now I have to figure out how this works when you have a spouse.

February is RRSP month. This is something that I was aware of in the back of my mind when I was younger, but now that I’m older, like April it’s a month that I have to G finances in order and TD. The handy tip while I was in school, but also receiving a handy income from coop, was to save up my RRSP deduction limit until I had a full-time job and need it to lower my tax bracket. Well my deduction limit for 2007 (first year as a full-timer) is over $20k but fortunately (or unfortunately) I don’t need to use it to lower my tax bracket.

Nevertheless, it’s still good practice to invest (and invest early) for retirement, so I will be contributing this month. My current thought is to invest 10% of my income in 2007. Why 10%? well next year, my deduction limit will increase by 18% of my income in 2007, but I’ve already contributed 4% (and IBM matches 4%) to my pension; so if I invest up to 10%, then the deduction amount I use up will be renewed by next year. Plus, I don’t have that much cash on hand anyways.

With that decided, now I have to figure out what to invest in. Thanks to high school math class, I have this idea in my head that mutual funds have a rate of return of 15% per year on average. But that mindset in the current market would be a disaster. While I’m confident that if I were to invest in mutual funds now, that they would eventually rise above water; I will also have to cash in my RRSPs in the short term as part of the RRSP Home Buyers Plan. I need something safe that will at the very least retain value; looking at my bank’s mutual funds offering, I don’t think that’s possible. So I’m now of the opinion that I will invest in a (redeemable) RRSP GIC instead. The rate of return is fairly low (3-4%) but at least it’s not negative.