The RRSP deadline has just passed us. You may have topped up your RRSP, you may have ignored the deadline, either way, if you are getting a RRSP refund, you need to know what you should be doing with it to take full advantage of it. I wrote a lengthy post highlighting how you should maximize your RRSP and it is all about how you use your RRSP refund in the end.
Related: How To Maximize Your RRSP
RRSP Refund – What is it?
What you need to know is that your RRSP Refund is a loan from the Canadian government. It’s not free money! The Canadian government is basically letting you use some money now in the form of a RRSP Refund knowing that later you will have to pay taxes on the money you put in your RRSP including any growth! This is a major difference with the TFSA where by no refund is given and no taxes needs to be paid when you withdraw.
RRSP Refund Planning
The planning of a RRSP refund should be really simple and no it should not pay for a vacation. You should have saved extra for that. Here are the few planning options that you really have to look at.
If you don’t re-invest your RRSP tax refund, your RRSP account looks like this. The graph assumes a $10,000 contribution annually growing at 4% for 25 years.
Re-invest Your RRSP Refund
The RRSP refund you receive should be re-invested. It needs to be put to work. It’s a loan from the government to help you accelerate your RRSP portfolio. It’s a form of compound growth. The best re-investment is to put it right back in your RRSP thus creating another refund at a later time.
I used to be able to finish my taxes in February and I would know exactly how much of a refund I would get so I would borrow and invest the refund right away for the current tax year to take advantage of the refund earlier.
Here is what your RRSP looks like with your refund re-invested. The numbers are quite different. That vacation now might look costly in the end if you used your RRSP refund to pay for it.
There are a couple of other scenarios where you can put your RRSP refund in a TFSA or even use it to pay more on your mortgage. Those two options definitely are putting your RRSP refund at work and to good use. The borrowed money from the government helps you financially.
For a detailed look at the different options and the result, see my post on maximizing your RRSP. You’ll find a couple more graphs comparing all the options. The RRSP tax refund is probably the best advantage the RRSP account has that you can benefit from as you get the right to invest the government’s money.
The tax-free advantage of an RRSP was a bit of a mirage in my opinion since you can buy stocks in a non-registered account and never pay taxes for 20 years while it grows. If you are a buy and hold investor, that’s tax-free growth and if you earn Canadian dividends, you pay a reduced tax on eligible dividends. With the TFSA introduction, there are much more ways to invest tax-free now.