RRSP gross-up strategy
Submitted by Nick Parnell on February 3rd, 2014Concept: RRSP gross-up strategy
What is the RRSP “gross-up“?
The registered retirement savings plan (RRSP) gross-up is a strategy that can be used to increase your RRSP contribution by taking out a short-term RRSP loan and paying it back before the monthly payments are scheduled to begin. If you select an RRSP loan with the option to defer payments, you should have sufficient time to receive your tax refund and apply it against the loan before your first payment is due.
Example:
John was contributing to his RRSP throughout the 2013 tax year. After a review meeting with his financial security advisor, John discovered some unused RRSP contribution room. John heard about RRSP loans, and wonders how one could be used to help him catch up on his unused RRSP contribution room. John's financial security advisor suggests an RRSP gross-up strategy where John takes out an RRSP loan for an amount that when added to his 2013 contributions, because of John's marginal tax rate (MTR), generates an income tax refund that pays off the loan completely. Furthermore, the loan repayments can be deferred from three to six months so that it results in minimal cost to John. He likes this idea however John's financial security advisor suggests that he discuss the strategy with his accountant to make sure all the numbers work out correctly before proceeding.
Let’s look at John’s situation given that all the numbers work out and he decides to move forward:
- Income of $90,000
- Estimated Marginal Tax Rate (MTR) = 38.29%
- Eligible contributions to RRSP throughout 2013 and January/February 2014 = $10,000
- Loan amount calculated as (eligible RRSP contributions * MTR)/(1-MTR) = $6200
- Loan rate 4%
- Deferred payment for three months
| Contribution (2013 and Jan/Feb 2014)) | Calculation to estimate refund | Refund action | Total contributed to RRSP | |
| Spend the refund | $10,000 |
Contribution x MTR = tax refund $10000 x 38.29% = $3829 |
Spend refund | $10,000 |
| Use refund for next year’s RRSP deduction | $10,000 |
Contribution x MTR = tax refund $10000 x 38.29% = $3829 |
Contribute refund | $13829 |
| Gross-up 2013 contribution with loan and use refund to pay down loan | $10000 + $6200 RRSP Loan |
Contribution x MTR = tax refund $16200 x 38.29% = $6200 |
Use refund to pay off loan | $16200 |
Important considerations:
- A portion of the RRSP contribution must not be borrowed money (i.e. have contributions been made throughout the year?)
- The expected tax refund should be the same as the amount borrowed (not including interest – there would be some interest that would accumulate from the month the loan went in, until you got your refund back to pay off the loan – probably about $10 to $20 depending on how long this would be)
- The tax refund must be used immediately to pay off the RRSP loan (this concept only works if your intentions for your tax refund are to pay back the loan; if you have other plans for your refund, this will not work)
- There must not be any outstanding personal tax liabilities (i.e. the proper amount of tax has come off of your income throughout the year)
- Any Home Buyer’s Plan or Life-Long Learning Plan repayments must be considered separately from the strategy, as they will not generate a tax refund (we currently do not have to worry about this)
- Any other deductions throughout the year? This is an estimated tax bracket based on discussions from our last review.
- Must be done by the end of February to count towards your 2013 income
- These numbers are estimates and may not be exact, but have the potential to be close if all the above points check off (always discuss/check with your accountant to make sure this strategy is right for you)
