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Employer contributions to RRSPs make sense

In May, 1996, a court in Sweden rejected an appeal by Elisabeth Hallin and her husband, who had been fined $680 (U.S.) for giving their son an unauthorized name. Their youngster has a name made up of 38 consonants followed by five numbers, which they pronounce "Albin," a name Ms. Hallin said is "a pregnant, expressionistic development that we see as an artistic creation."

I shared this story with my wife Carolyn the day our son was born this week. You see, he's our third child and we've been debating over names for him. After the story, I figured she'd be less likely to call me crazy for any particular name I suggest. I'm in favour of the name Numchuck, which apparently means "big tax savings."

And big tax savings may be just what the doctor ordered this registered retirement savings plan season. Let me talk about a terrific strategy that you should consider. I'm referring to employer-direct RRSP contributions.
The strategy

If you're wondering how to maximize your RRSP contribution this year, consider approaching your employer to help out. You see, your employer is able to pay all or a portion of your compensation, including bonuses, to your RRSP at any time.

Provided that your employer believes, on reasonable grounds, that you've got sufficient RRSP contribution room available, your employer can contribute some of your compensation directly to your RRSP and bypass the requirement to withhold income tax on that amount. While you won't escape the requirement to make Canada Pension Plan contributions, or to pay Employment Insurance premiums on that compensation, the income tax savings will enable you put a lot more into your plan.
The benefits

The benefits are great. Consider Shawn's example. Shawn received a $10,000 bonus this week from his employer. If his employer had paid the amount directly to Shawn, taxes of $4,600 would have been withheld (assuming a 46-per-cent marginal tax rate), leaving Shawn with just $5,400 to contribute to his RRSP. That $5,400 contribution would save Shawn taxes of $2,484 ($5,400 x 46 per cent) in 2002.

Shawn's employer, however, paid the $10,000 directly to Shawn's RRSP carrier as a contribution to his RRSP with the understanding that he had sufficient RRSP contribution room.

In this case, the full $10,000 made its way to the RRSP because income tax withholdings were bypassed.

The tax savings on a $10,000 RRSP contribution in Shawn's case is $4,600 -- much higher than the $2,484 he would have had.

What's really happening here? The tax savings that result from the $10,000 RRSP contribution are effectively refunded to Shawn at the time of the RRSP contribution by his employer, and those dollars make their way into his RRSP. As a result, Shawn should not expect a refund when he files his tax return for 2002.

I particularly like this strategy when it comes to bonuses paid early in each new year. Why? Because you'll be entitled to a deduction in the prior year for the contribution, but you won't pay tax on the bonus until the year it's paid out. So, if you received a bonus in January, 2003, that was contributed by your employer to your RRSP, you'll be entitled to an RRSP deduction in 2002, but won't pay tax on the bonus until 2003.

Since effective tax rates are expected to be lower in 2003, thanks to the indexation of our tax credits and brackets to inflation, you're likely to come out ahead as a result of this lag time.
The details

There's no need to apply to the Canada Customs and Revenue Agency (CCRA) for approval to reduce the tax withheld on the contribution. Regulation 100(3)(c) of Canadian tax law permits your employer to bypass the income tax withholdings on the amount contributed to your plan.

Your employer needs to have reasonable grounds for believing that you've got sufficient RRSP contribution room. Your employer may simply ask you to verify in writing that you've got sufficient room. This requirement became effective June 7, 2001, when the regulations were amended.

Your employer can simply make the cheque payable to your RRSP carrier, with a note that it is to be deposited to your RRSP account. The amount contributed to your RRSP will show up on your T4 slip for the year it is paid out, but you'll receive an RRSP deduction slip on the flip side to offset that income.
Tim Cestnick, CA, CFP, TEP is author of The Tax Freedom Zone and Winning the Tax Game 2003. He is managing director, Tax Smart Services, at AIC Ltd.
tcestnick@aic.com



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