I did some calculations on my previous impressions of whether I should claim my RRSPs this year, or save them to lower my tax bracket in the future. Now that I have some clear numbers, it seems worthwhile to save my contributions for the immediate future.
Based on 2007 figures tax rates, the federal tax bracket is ~$74k while the Ontario tax bracket is at ~$71k. For simplicity, let’s say that both tax brackets are at $73k. The federal tax rate moves from 22% to 26% while the Ontario rate moves from 9.15% to 11.16%. Overall, when you exceed the tax bracket, you pay an additional 6% more tax on the excess amount over the boundary. Let’s say I made $80k in 2007 and so had to pay an additional 6% on the extra $7k, or $420. To prevent this extra tax, I could use $7000 in RRSP contributions. So the question is, what would have been my opportunity cost for that $7k in RRSPs?
Regardless of when you claim the RRSP, you have to pay 22%+9.15% (let’s say 32%) tax on the $7k. If you claim the RRSP in the future, then you save the extra 6% ($420) tax you would have paid. However, if you claimed the RRSP in the past, you would end up with an extra 32% ($2240) to play with for a couple of years. Now, compound interest comes into play. If you delay a year, then you need to earn 18.75% interest in order to break even. A pretty unlikely goal, so delaying one year is worth it. The percentages work out to { 8.9%, 5.9%, 4.4%, 3.5% } for 2-5 years into the future.
From those numbers, it seems worth it to delay RRSP contributions by 2 years, 3 at the outset. Since the numbers are ratio based, it would work the same for $3000 or $15000 in contributions, although remember that it’s based on the assumption that you will exceed the (moving) tax bracket boundary by the equivalent of your saved contribution within 3 years. If your income is steady, then your rate of return on the open market will need to be much less in order to break even, so then it’s better than claim the RRSP benefit immediately (provided you’re not going to waste the money on candy).
Now I have to figure out how this works when you have a spouse.
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