The Tax Thread

[backmarkerducati]

Forum Sponsor

My shot at the dumb question of the day... RRSP Contribution Scenario

Lets say you have a 10K (for easy math) bonus and your employer offers to pay it out or to contribute to an corporate group RRSP. Also for easy math assume a 50% tax bracket for all math, no TVM, an RRSP that will be flat, lots of RRSP room, very low tax bracket when the RRSP is cashed in.

Scenario 1:
You take the cash, they withhold 5K in taxes (50%) so you get 5K in cash after taxes. You then contribute the 5K to your personal RRSP account which results in a $2500 tax return. So net you have $7500, 5K in RRSP and $2500 in walking around money (or that you put into next year's RRSP..).

Scenario 2:
They drop the $10K into the group RRSP which is before taxes. You don't pay any taxes on the $10K so you have $10K but all in RRSP.

I feel like I am missing something here... or maybe not????

 

[GreyGhost]

My shot at the dumb question of the day... RRSP Contribution Scenario

Lets say you have a 10K (for easy math) bonus and your employer offers to pay it out or to contribute to an corporate group RRSP. Also for easy math assume a 50% tax bracket for all math, no TVM, an RRSP that will be flat, lots of RRSP room, very low tax bracket when the RRSP is cashed in.

Scenario 1:
You take the cash, they withhold 5K in taxes (50%) so you get 5K in cash after taxes. You then contribute the 5K to your personal RRSP account which results in a $2500 tax return. So net you have $7500, 5K in RRSP and $2500 in walking around money (or that you put into next year's RRSP..).

Scenario 2:
They drop the $10K into the group RRSP which is before taxes. You don't pay any taxes on the $10K so you have $10K but all in RRSP.

I feel like I am missing something here... or maybe not????

Most bonuses pay out in pre-tax dollars so you feel like they care more. So ime, you'd have a cheque for 10K and a tax liability for 5K if you didn't put it in RRSP. Your math isn't mathing because you are mixing up pre and post-tax money.

 

[backmarkerducati]

Most bonuses pay out in pre-tax dollars so you feel like they care more. So ime, you'd have a cheque for 10K and a tax liability for 5K if you didn't put it in RRSP. Your math isn't mathing because you are mixing up pre and post-tax money.

It is paid out with taxes deducted. As an employee every bonus I have ever received from any company had taxes deducted...

But in the same context it could just be regular pay:
They take $100 per pay and put it into the group RRSP pretax vs
Same $100 pretax in pay that gets taxed at 50% and you put the $50 you get into your RRSP every pay, and get $25 back at tax time.

The pretax deduction comes out way ahead???

 

[GreyGhost]

It is paid out with taxes deducted. As an employee every bonus I have ever received from any company had taxes deducted...

But in the same context it could just be regular pay:
They take $100 per pay and put it into the group RRSP pretax vs
Same $100 pretax in pay that gets taxed at 50% and you put the $50 you get into your RRSP every pay, and get $25 back at tax time.

The pretax deduction comes out way ahead...

There are a few ways around your paradox.

Your scenario 1 got you 7500 this year but if you put the 2500 into rrsp, that gets you 1250 next year and so on. It's and infinitely decaying series that eventually gets you 10k (7500>8750>9375>9687.5>9843.75>. . . )

The cleanest way to turn scenario 1 into 10K now is to take the 5K from the company and 5K from somewhere else (other cash, borrowed, etc) and put 10K into your rrsp which generates a 5K refund. That 5K refund pays off the 5K you got from somewhere else. More hassle but you got 10K in RRSP in year one as with scenario 2. Is the return in your personal RRSP high enough that avoiding the easy path to the corporate plan is worth the hassle? For me, yes, for many people, no (especially if they spend it instead of investing it).

 

[Mad Mike]

There are a few ways around your paradox.

Your scenario 1 got you 7500 this year but if you put the 2500 into rrsp, that gets you 1250 next year and so on. It's and infinitely decaying series that eventually gets you 10k (7500>8750>9375>9687.5>9843.75>. . . )

The cleanest way to turn scenario 1 into 10K now is to take the 5K from the company and 5K from somewhere else (other cash, borrowed, etc) and put 10K into your rrsp which generates a 5K refund. That 5K refund pays off the 5K you got from somewhere else. More hassle but you got 10K in RRSP in year one as with scenario 2. Is the return in your personal RRSP high enough that avoiding the easy path to the corporate plan is worth the hassle? For me, yes, for many people, no (especially if they spend it instead of investing it).

I would say if you don’t need the cashola, all RRSP would be the best in the long term. (You don’t need to contribute to company’s plan to get the tax benefit. Your company gets some benefits when you contribute thru them: It lowers some payroll costs, and they may get some kickbacks from the fund manager. Also, may not get the best returns thru company plans as they usually have higher management fees that you pay).

If you carry credit card debt (or any high interest debt) its usually smarter to pay the income tax then use $5k to pay down the debt. That’s a guaranteed return of 20%.

If you’re have a spouse and they make less than you do, it’s a good idea to try to balance out your rrsps at the point if retirement. Contribute to a spousal RRSP.

Better yet, talk to a financial planner or tax focussed CPA.

Forum Sponsor