In addition to the income tax refund, RRSP contributions may also open up access to certain income-tested benefits.VectorKIF/iStockPhoto / Getty Images
Most clients know that RRSP contributions are a highly effective way of saving for retirement, but some parents may be missing out on additional income-tested benefits accessed through those contributions.
A client in Ontario who earns $150,000 in 2024 would owe $42,377 in taxes at a marginal tax rate of 43.41 per cent. Due to employer and payroll taxes, most of the $42,377 is withheld from their paycheque already and disclosed on their T4s. In most cases, they end up with a small refund after claiming some other credits.
If that client contributes $20,000 to their RRSP, their net income is reduced to $130,000 (instead of $150,000). On an income of $130,000 in Ontario, the taxes owed are $33,695. Compared to the original $42,377, that’s a difference of $8,682, or 43.41 per cent of $20,000. Consequently, the client’s tax refund increases by $8,682.
That’s beneficial today but the client will owe income taxes on future RRSP withdrawals, so an RRSP is most effective when contributing at a higher tax bracket and withdrawing in the future at a lower tax bracket. Yet, what clients may not realize is that in addition to the income tax refund, RRSP contributions may also open up access to certain income-tested benefits.
The hidden benefit for families
Many government benefits – including the Canada Child Benefit (CCB), which affects most families with children under 18 years old – are income-tested, meaning clients with income above certain thresholds may qualify for less of those benefits.
While some specific benefits such as the Canada Learning Bond for registered education savings plans or the adoption subsidy are an “all or nothing” benefit (those above the household income level don’t get the credit), most standard benefits are tiered down on a per-dollar basis, like an additional marginal tax. For the CCB, that’s based on household income and number of children.
Families whose household income exceeds $37,487 will see the maximum entitlement – $7,997 annually for each child under 6 years of age or $6,748 annually for each child aged 6 to 17 – reduced by 7 per cent for one child, 13.5 per cent for two children, 19 per cent for three children and 23 per cent for four or more children. Once the household income surpasses $81,222, the CCB entitlement will be reduced by an additional 3.2 per cent for families with one child, 5.7 per cent for families with two children, 8 per cent for three children and 9.5 per cent for four or more children.
For example, a family with a household income of $81,222 with one child under six would receive a CCB of $4,935.55, or $411.29 a month. If that family earned an extra $1,000 dollars, the CCB would decrease by $32 (3.2 per cent x 1,000) to $4,903.55, or $408.63 a month.
In essence, that’s an additional marginal tax as it results in less money for those families directly. But they’ll never see it on their tax return.
However, household income for the CCB is determined after RRSP contributions have been taken into account. That means an RRSP contribution not only helps defer income taxes and reduce taxes owing, but it also increases CCB for that year.
Let’s consider the scenario earlier on in which a client earns $150,000 annually with a spouse who doesn’t earn any income. The couple has three children. A $20,000 RRSP contribution in Ontario will result not only in the $8,682 of tax savings/deferral discussed earlier, but in an additional $1,600 of CCB ($133.33 a month). That means the total tax reduction of $10,282 is equivalent to a true “effective marginal tax rate” of 51.41 per cent.
When we compare this to the typical expected retirement marginal tax rate of 20.05 per cent to 29.65 per cent for most retirees in this income category, there are massive tax savings to utilizing the RRSP.
In many cases, even a household with someone earning income at the top tax bracket may potentially qualify for the CCB if they have multiple children. That means effective marginal tax rates approaching 60 per cent for the benefit. Even in cases that would result in Old Age Security clawbacks or dying with a large RRSP that’s fully taxable, the family would still be better off contributing to their RRSP.
The CCB is one of the few government benefits that impacts a majority of the working population, including middle- to higher-income families. For those earning less, other benefits apply including the HST/GST credit and, for Ontarians, the Ontario Trillium Benefit and the Ontario Child Benefit.
For a family with a single income of $65,000 with three children, these benefits, combined with the CCB, add up to a whopping 38 per cent clawback in Ontario. In addition to the 29.65 per cent income tax rate, the family’s effective marginal tax rate for these benefits is 67.65 per cent.
In this scenario, a $5,000 RRSP contribution would net an additional $1,482.50 in income tax savings and $1,900 in various benefits, for a total of $3,382.50.
The key takeaway? Clients with children shouldn’t ignore these income-tested benefits – especially the CCB – when calculating the total savings for RRSPs, as they could amount to thousands of dollars every year.
Aravind Sithamparapillai is an associate at Ironwood Wealth Management Group in Fonthill, Ont.