This post applies to couples who are married and currently living in Canada. There are many great strategies to maximize one’s retirement savings but this strategy specifically benefits those who are married and enables these couples to stretch their investment dollar to its fullest potential!
For starters, the spouse with the highest income should maximize their contributions invested inside their RRSP each year. The higher income spouse will receive the larger tax refund at their marginal tax rate.
Next, take the refund from the higher income spouse, and invest the refund into the lower income spouses RRSP. This will ensure that both spouses will not only get tax refunds from their RRSP contributions, but they will also be saving towards their retirement, which has now been boosted!
The final piece to the strategy is to take the refund from the lower income spouse and put it towards each spouse’s tax-free savings account (TFSA). With this strategy, potentially both spouses were able to maximize their RRSP contributions, and invest money towards their tax free savings accounts.
You will read different investment articles outlining the benefits of investing towards your RRSP first as opposed to your TFSA or visa versa. Many believe (including myself) that it’s more advantageous to invest towards your RRSP first if you are in a higher tax bracket today while you are working, and will be in a lower tax bracket at retirement. For this reason I focus my retirement investments towards the RRSP first and then the TFSA secondly.
In this example if someone was to invest $20,000 in after tax dollars in their TFSA alone, then they would have a $20,000 investment at most. While this is great, investing in the strategy that I proposed above will net you over 50% more!
Take for example a spouse who is in a 40% income tax bracket who invests the same $20,000 into their RRSP. They will get an $8000 tax refund. Then they can contribute this refund towards the lower income spouses RRSP, who is in a 30% tax bracket. This spouse will receive $2,400 as a tax refund which they can then invest into their TFSA. The total proceeds invested was the original $20,000 but netted them $10,400 in addition for total proceeds invested of $30,400 as opposed to just $20,000!
This strategy is quite simple and can be applied to everybody regardless of your income or net worth. Some will still argue that the after tax dollars invested into the TFSA will be more beneficial having access to them tax free in the future, but I would argue the opposite. I suggest that the compounding effect of the higher amount invested over the same period of time will benefit the investor far greater! $30,400 invested and compounding over time will be worth substantially greater than only $20,000 compounding over the same period of time. Plus, the 50% immediate return on your investment will far exceed any tax brackets you will be in at retirement which will be much less!
There are however two important things to keep in mind with this strategy:
The first is to make sure that you have invested all of your RRSP contributions prior to filing your income tax return. Otherwise you will not receive a tax refund if the contributions are made after. This is also based on the assumption that you have paid all the necessary taxes to your local tax authorities and that a refund is due back to you.
The second thing to keep in mind are tax and RRSP deadlines. Each spouse will need to top up their RRSP’s prior to the deadline which is the end of February. The tax filing deadline is at the end of April, so in order to benefit and receive the tax refund you will need to contribute to both the higher income spouse AND the lower income spouse BEFORE either one receives a tax refund. You will only receive a tax refund after you have filed your taxes. Keep in mind that you can file your taxes as soon as you have received all of your necessary tax slips from your employer, brokerages, etc. In most cases, this can happen at the end of February to coincide with the RRSP contributions, however in the event that you may file your taxes after the RRSP deadline, you may need to front load the lower income spouses RRSP out of pocket and pay your self back after you receive the tax refund.
Here’s to you and your retirement investing! Please feel free to drop a comment or ask any questions below!
-RAFI
