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Turn RRSP contribution room into dollars

This is really simple – and is best used only by someone who has a husky taxable income in 2011, and expects a radically lower income in 2012. All you do is make a very large contribution before February 29, 2012; generate the associated refund when you file your taxes; and then withdraw the same money three months later. Just by moving money around like this, you can generate thousands of tax refund dollars.

Important!

Jealous of Fraser Smith’s fame as the ‘pioneer’ of leveraged investing via tax deductible mortgages, I have decided this little used RRSP manoeuvre deserves a name. Hence “The Taylor Manoeuvre”.

I have used this strategy myself in my youth, and it came up again last week when a young professional named Megan came to me for a consult. She explained she had just quit her job as an assistant marketing manager, and was starting her own business. To supplement her erratic income in the early months, and ensure she can pay her bills no matter what, she will also be working part time as a waitress in an upscale restaurant.

First of all, I applaud Megan for not being afraid to pursue her dream. Yes she is debt free, but it still takes courage to give up the good life, and pursue personal fulfillment and join the ranks of the self- employed to boot.

I noted Megan has over $35,000 of accumulated unused contribution room, and according to her 2011 T-4, she made around $57,000 in taxable income in 2011. A large chunk of that was taxed at a marginal rate of 40%.

I checked with my tax accountant,  and he confirmed Megan would generate around an $8,000 refund this spring if she makes a $20,000 RRSP contribution before the end of February.

We discussed arranging an RRSP loan for this amount – but Megan correctly pointed out she could simply draw down the funds from her personal line of credit, and transfer $20K into her RRSP at the same bank. Simple! At an interest rate of 7%, the cost of borrowing this money for three months will only be $350. (yet another benefit of having an awesome credit score)

After she has held the money inside her RRSP for three months, Megan plans to withdraw it in $5,000 increments. As an Ontario resident, each withdrawal will be subject to withholding taxes of only 10%. (In Quebec it is 21%)

By the time the dust settles in late May, this young lady will have netted $6,000 in ‘profit’, at a cost of only $350.

One year from now, time will tell if the final result will be even better, or possibly slightly worse. You see the 10% withholding tax is like a security deposit with CRA – it is not a final number. Megan and her tax accountant are confident she will retain the full benefit. If there was an expectation of a high personal income in 2012, this would not be an attractive strategy for Megan.

Who might consider the Taylor Manoeuvre?

  • People taking a break from work to go back to school, or simply taking a leave of absence.
  • People like Megan who intend to leave the ranks of the salaried, and enter into business for themselves.
  • People who have an unusually high taxable income in 2011, and are confident their marginal tax rate will be much lower in 2012.

Of course, you need to have some unused RRSP contribution room; you need to be pretty confident in your income projections; and you would be well served to consult your own tax accountant before you jump in.