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RRSP overcontributions in final year can boost your nest egg

When it comes to the last year for making contributions to your registered retirement savings plan, a little creativity can help you boost the final value of your portfolio. Here is one approach to take.

The strategy

Thousands of Canadians turned 69 this year. And if you're one of them, you're probably aware that your RRSP is maturing this year. That's right, you've got to decide what to do with your RRSP since you can't have an RRSP beyond the end of the year in which you reach age 69. The "RRSP advance contribution" strategy works wonders if you're 69 this year, but still have "earned income" (income from employment, self-employment, or net rental income, for example).

Suppose, for example, that you are 69 this year, and have earned $100,000 this year. The $100,000 of earned income will provide you with $18,000 of RRSP contribution room next year (the maximum RRSP contribution in 2006). The problem? You won't have an RRSP to contribute to next year. Is there a way to take advantage of that RRSP contribution room somehow? Sure. You can make that contribution in December of this year, just prior to winding-up your RRSP.

If you've already maximized your RRSP contributions this year, this $18,000 contribution will be considered an overcontribution to your plan in December. The penalty is 1 per cent of the excess contribution per month. So, for the month of December, the penalty will be $160 (you're allowed a $2,000 overcontribution without penalty). You'll be glad to know that the penalty will apply for the month of December only, because you'll be entitled to $18,000 of contribution room on Jan. 1 next year, putting an end to your overcontribution problem.

The benefit

The real benefit of this idea is that you'll now be able to claim an RRSP deduction next year of $18,000. This will save you tax of $7,814 if we assume your marginal tax rate will be the same next year. So, you'll save $7,814 in tax in 2006, and all it will cost you is $160 in overcontribution penalties.

Hmm. What if you also expect to have earned income in 2006 (perhaps another $100,000 like this year)? You might consider making your 2007 RRSP contribution in December of this year as well. This would result in total overcontributions in December of $36,000. What does the math look like? You'd have overcontribution penalties totalling $2,080 from December, 2005, to December, 2006. But your tax savings would amount to $15,628 ($7,814 for each of 2005 and 2006).

Keep in mind, you'll want to wait until December to make an RRSP advance contribution, to minimize your penalties. Also, your overcontribution should not equal more than your expected RRSP contribution room, which can be calculated as 18 per cent of your earned income.

Tim Cestnick, FCA, CPA, CFP, TEP, is a tax specialist and author of Winning the Tax Game 2005 and The Tax Freedom Zone.

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