How RRSP Contributions Affect Your Government Benefits
Fee-for-service financial planner and founder of PlanEasy.ca
RRSP contributions can be a great tool to help manage your income taxes before and after retirement. They can also be a great tool to help manage your government benefits in a similar way. RRSP contributions affect government benefits like the Canada Child Benefit (CCB), Ontario Child Benefit (OCB), Guaranteed Income Supplement (GIS), GST/HST Credit, Ontario Sales Tax Credit etc etc.
What many people may not realize is that most government benefits have a “claw back” rate that acts like a tax rate. If you earn more income the “clawback” rate will reduce your government benefits. But the opposite also happens, if you make an RRSP contribution and your income goes down, then this “clawback” rate will work in reverse and it will increase your government benefits!
There are a couple situations where RRSP contributions can have a BIG effect on government benefits. Let’s take a look at two real life examples.
One example is a senior who is receiving GIS benefits. We’re going to plan some strategic RRSP contributions to help them maximize their GIS benefits. This is counter-intuitive, we’re always told that TFSAs are best for low-income individuals, but in this case we can use RRSP contributions strategically to maximize GIS.
The second example is a young family with three children. They’re receiving the Canada Child Benefit and the Ontario Child Benefit and we’re going to plan some strategic RRSP contributions to help them maximize their family benefits.
RRSP Contributions For Seniors Receiving GIS
Making a strategic RRSP contribution is one of the most interesting planning opportunities for seniors who are receiving GIS. RRSP contributions can be used to “offset” other income from sources like CPP. This can help a low-income senior maximize GIS for a few years.
This strategy can be very impactful because GIS has a “clawback” of 50% to 75%. This means for every $1,000 in RRSP contributions we’ll be able to increase our GIS by $500 to $750. Not a bad return!
The challenge is that at some point we need to withdrawal all these RRSP contributions. This withdrawal has an impact, but the net effect of maximizing GIS is that we still come out further ahead.
To illustrate this example let’s look at a scenario. We have a low-income senior who just turned 65 this year. She’s fully retired and has started CPP. She will receive $9,000 per year from CPP and the maximum $7,362 per year from OAS. The rest of her income comes from her $80,000 TFSA.
With $9,000 of CCP income she will see a reduction in her GIS benefits but she will still receive $4,793 per year in tax free benefits from GIS. OAS income does not impact GIS benefits, nor does income withdrawn from a TFSA.
But, with a strategic RRSP contribution of $9,000 we can maximize her GIS. We can shift $9,000 from the TFSA into an RRSP and offset the CPP income. This reduces her income to zero and she will receive the maximum GIS benefit of $10,997, an increase of $6,204! That’s an average return of 68.9% on our $9,000 RRSP contribution! Wow!
But we do need to withdraw these funds eventually, so let’s see how this plays out over the course of 8-years until age 72 when we’re forced to start RRIF withdrawals…
GIS: No RRSP Contributions
Maximizing GIS: With RRSP Contributions
With some strategic RRSP contributions we’ve received an extra $38,635 in GIS benefits over 8-years and an extra $17,632 in net cash flow available for spending!
RRSP Contributions For Families Receiving CCB/OCB
Strategic RRSP contributions can also help families maximize their family benefits. Benefits like the Canada Child Benefit and the Ontario Child Benefit have high claw back rates, when combined with regular income tax rates the combination of income tax and benefit clawbacks can reach 50%, 60% or even 70%+.
Making RRSP contributions means that a family can get the most out of their savings. It does require some planning and foresight. We assume that our family will be able to withdraw these RRSP contributions in the future at much lower tax rates when the children are fully grown.
TFSAs can often be the saving vehicle of choice for low and moderate income families. They’re easy, flexible, and tax free. But a well timed RRSP contribution will help maximize their available savings.
To illustrate this let’s look at an example. We have a family with 3-children under 6. One partner stays at home with their children while the other partner earns approximately $60,000 per year. Cash flow is tight but they’re still able to save $5,000 per year after-tax. They’re deciding between a $5,000 TFSA contribution and a $5,000 RRSP contribution.
Before we look at the two contributions, lets understand their tax and benefits clawback rates…
- Marginal Income Tax Rate: 29.65%
- Canada Child Benefit Clawback Rate: 19.00%
- Ontario Child Benefit Clawback Rate: 8.00%
- Ontario Energy and Property Tax Credit Clawback Rate: 2.00%
- Ontario Sales Tax Credit Clawback Rate: 4.00%
Total Marginal Effective Tax Rate: 62.65%
The first option is to put the $5,000 in the TFSA. This is easy and makes these funds very accessible in the future. This would give us a $5,000 balance in the TFSA.
The second option is to put the $5,000 in the RRSP. This would create a $5,000 tax deduction which would help reduce income tax and government benefit clawbacks. Between the tax refund and increased benefits, the $5,000 RRSP contribution creates $3,131.50 in after-tax savings at 62.65% which could be placed in the TFSA ($5,000 x 62.65%). So with the RRSP option we end up with $5,000 in the RRSP plus $3,131.50 in the TFSA for a total of $8,131.50 in savings!
Obviously we’ll need to pay tax on these withdrawals in the future, but if withdrawn at a 20% tax rate (with some good pre-planning and income splitting in retirement) the net effect is that this family comes out much further ahead by making an RRSP contribution.
Using RRSP Contributions To Maximize Your Financial Plan
These are just two basic examples of how strategic RRSP contributions can help you maximize your financial plan. Understanding the impact that RRSP contributions can have on your plan will ensure that you’re reaching your goals in the easiest way possible.
RRSPs and spousal-RRSPs provide a number of financial planning opportunities to help make the most of your savings.
But… just like a well time RRSP contribution helped improve the financial situation in our two examples, a mistimed RRSP contribution can work against you.
Find out when and how much you should be contributing to an RRSP by working with an advice-only planner. We help our clients plan contributions and withdrawals from RRSPs, TFSAs, RESPs etc. We create a cash flow plan that ensures our clients are maximizing the planning opportunities over time. This can be worth $1,000’s!
Financial planner, personal finance geek and founder of PlanEasy.