Personal Finance

Overcontributing at age 71 could pay off.
By Matthew Elder | 12/02/18

You're in the home stretch toward retirement, reviewing your savings and comparing your tax situations now and after you stop working. Where does the registered retirement savings plan (RRSP) fit into all this? Should you continue to contribute as much as you can, while you can?

About the Author
Matthew Elder is Principal of Sensible Communications, a Toronto-based communications consultancy specializing in the financial services industry. He has more than 30 years' experience in financial journalism as an executive, editor, columnist and reporter. He is a former Vice President, Content & Editorial of Morningstar Canada. Previously, he was an editor and columnist at the Financial Post and The Gazette in Montreal.

While there is no one-size-fits-all answer, in some cases adding to an RRSP may no longer be your best strategy. And from a long-term taxation standpoint, it may even be worth beginning to transfer assets from your plan to a taxable account early.

An RRSP must be converted to a registered retirement income fund (RRIF) or registered annuity by the end of the year in which you turn 71. Your savings remain invested in the RRIF or annuity and taxed as you make withdrawals, theoretically at a lower tax rate than during your higher-income working years.

If your post-retirement income is likely to be less than what you are earning during your final working years, it probably makes sense to keep contributing as much as you can to your RRSP, thus increasing your savings both through new contributions and continuing tax deferral. You'll probably pay less tax on the proceeds after retirement because you'll be in a lower tax bracket.

You may even want to continue making contributions to a spousal RRSP after age 71 if your spouse is younger and therefore still eligible. However, if you expect your income after age 71 will be higher than it is now, it may be worth beginning to gradually withdraw funds from your RRSP and pay the tax on these proceeds now.

A higher post-retirement tax liability could be in the cards if you are now working part-time and have built a large RRSP portfolio and/or are expecting to receive a sizeable inheritance or other windfall. If your current income is relatively low, the deduction from making an RRSP contribution won't be worth much and you'll still have to pay tax on the eventual proceeds at your marginal tax rate later.

Contributing now, deducting later

However, you are allowed to make an RRSP contribution now, but delay claiming the resulting deduction until any future taxation year, presumably when your income is higher and the deduction will be more valuable to you.

"Unclaimed RRSP contributions can be carried forward indefinitely and therefore can be used in the future, even after age 71, to reduce taxable income," says Mohamed Sheibani, a partner with Deloitte Private.

If your income decreases during the years preceding retirement, this will reduce the amount of new RRSP contribution room created each year. In such a situation you might consider "melting down" your RRSP," Sheibani says. "This can allow you to better manage the RRSP balance before it becomes a RRIF. From an estate-planning perspective, carrying forward a large RRSP can have negative consequences, since the full RRSP or RRIF is generally brought into your final income-tax return, unless you have a spousal rollover."

Impact on OAS clawback

Another important consideration is the impact of RRIF or annuity income on your Old Age Security benefits, which you can begin receiving the month after you turn 65. You can defer beginning to receive OAS for up to five years from the eligibility date. The monthly pension payment is increased by 0.6% for every month you delay receiving it, up to a maximum of 36% at age 70.

However, if your income is reasonably high, the amount of OAS you receive will be subject to a recovery tax (known as a "clawback"). For 2018, the clawback kicks in at approximately $75,000 of net income and OAS is completely clawed back at income of about $121,000. The income threshold and range are based on your net income in previous taxation years. This is calculated as follows: for the first half of 2018, the net income stated on your 2016 income-tax assessment. And from July onward, your 2017 net income is used.

"If you have a large RRSP and the resulting RRIF income would result in you having to claw back your OAS, you may want to reduce the balance of the RRSP to a point where it would not trigger the clawback," Sheibani says.

However, the ability to retain as much of your OAS benefit as possible during your pre-RRIF years can be a vote in favour of continuing to make RRSP contributions from ages 65 to 71, he says. "Net income is an amount after the RRSP deduction and therefore an RRSP deduction would reduce the net income upon which the clawback of OAS is calculated."

Over-contributing at age 71

There is an interesting twist available that can allow you to make a final, sizeable contribution to your RRSP for the year after you turn 71.

Say you are still earning income and are turning 71 in 2018. You are allowed to contribute the maximum amount for 2018, based on your 2017 earned income. Normally, you would have until March 1, 2019 to make this contribution -- and still have it deductible on your 2018 tax return. But because this is the final year of your RRSP, you must contribute by the end of calendar 2018.

First, make your maximum RRSP contribution this year for a 2018 tax deduction. Next, at the beginning of December 2018, contribute the maximum allowable RRSP contribution for 2019, based on your 2018 earned income. Then, as you are required to do, convert your RRSP to a RRIF before the end of December 2018.

You will be penalized for making an RRSP overcontribution for 2018. The penalty for doing so is 1% per month of the overcontributed amount, less the $2,000 that anyone is allowed to overcontribute on a cumulative basis without penalty.

So, if you were entitled to the maximum $26,230 contribution for 2019, calculated from your 2018 earned income, the amount of overcontribution during December would be $24,230 ($26,230 less $2,000). The 1% penalty per month would be $242.30.

But as of Jan. 1, 2019, your contribution room for the new year would be $24,230. This would bring your overcontribution in December 2018 onside. And it would allow you to claim an RRSP deduction when you file your 2019 income-tax return. The after-tax value of that 2019 deduction would be far greater that the penalty paid on the 2018 overcontribution.

A cash-flow plan is the key

Overall, how long you continue to make RRSP contributions during your 60s depends on your overall retirement-savings strategy. "If you have other income coming in future years -- from inheritance, an employer pension from you or your spouse's employment and the like -- you may want to consider putting less money in your RRSP and instead begin melting it down," Sheibani says. "The key is to make sure you have a cash-flow plan for your retirement," he says. "This will allow you to make the right decision based on your individual situation."

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