Continuing our discussion in RRSPs, Canadians can use the RRSP very effectively to save on taxes for education planning. Although RRSPs can be used to finance education for young people just out of high school, this isn't a common option for most middle-class Canadians. If your parents are extremely wealthy and transfer money to you through small business corporations and other schemes, you should have no problem paying your local balding accountant for tax saving strategies. (Your parents will probably foot the bill.)
For this strategy, I will be discussing the use of RRSPs for education later in life. Education upgrading is becoming a whole lot more common as our economy evolves. Using tax savings money can make adult education a hell of a lot more feasible.
Dutifully hammering the point home again: RRSPs are a tax-deferral strategy, RRSPs are great tools for tax savings when you contribute in high earning years and withdraw in low earning years. Whenever you contribute to an RRSP, always invest the tax refund as you will be taxed on all withdrawals later!
Don't forget when you plan to save for shorter time periods it is important to reduce your portfolio volatility. If you choose to follow the Growth Portfolio, adjust up your bond allocation and reduce your stock allocation. Combined stock ETFs should not be more than 50% of your portfolio.
Lifelong Learning Plan
The first great element of RRSPs for education saving is the Lifelong Learning Plan (or LLP). Under the LLP, you can essentially borrow up to $20,000 from your RRSP—or your spouse's RRSP—for full-time education purposes.
The max LLP withdrawal per year is $10,000. And don't contribute to your RRSP less than 90 days before making a LLP withdrawal or it will negatively affect your contribution room forever.
LLPs could be thought of as a personal loan you make to yourself from your RRSP. The withdrawals under the LLP are not taxed and you don't have to report them as income on your tax return. Also your repayments don't affect your new contribution room down the road when you're back to work.
However, you have to pay those LLP withdrawals back to your RRSP over a maximum 10 year period following your education (normally 1/10th of your total withdrawal each year). Your repayment period begins no later than 5 years after the first LLP withdrawal in any case and no later than 2 years after being a student with at least 3 months of full-time education on your tax return.
If you can't make the repayments, the required minimum payment for the year will be added as taxable income on your tax return—don't let that happen!
The Income Shift
The other part of using RRSPs for adult education is a simple income shift from a high income working contribution year to a low income education year withdrawal. These withdrawals can be in addition to LLP withdrawals but they are taxable as regular income.
Keep in mind, most provinces have virtually no income tax on earnings under $12,000. Unlike the LLP withdrawals, when you take a standard withdrawal from your RRSP you lose that "RRSP room" forever.
Example Case Study
Jessica graduates from university with her Bachelor's degree when she is 24. She plans to go back for her Master's degree when she is 30, but wants to get some work experience first. She finds a job in B.C. that currently pays $60,000 a year.
She expects to earn $90,000 a year if she has her Master's degree combined with her experience. She wants to contribute the maximum yearly amount to her TFSA for retirement.
After her expected Master's grant money, she estimates she will need about $1,200 per month in additional income during her 2-year Master's education. Based on this calculation, she only needs to contribute $4,000 a year towards her RRSP including reinvestment of the refund ($1,130).
We'll assume Jessica makes no TFSA contributions while she's studying, but resumes after that. Once she get's her new job she immediately starts paying back $2,000 a year to her RRSP for the LLP payments and maxing her standard RRSP contributions at 18% of her income.
Although she only contributed $4,000 a year to her RRSPs for education needs, Jessica still saved a total of $6,780 in taxes during her first 6 working years and didn't pay a penny back in tax when she took the withdrawals because of her low income. By using the LLP, she didn't lose most of her "RRSP room" and can still make full contributions once she is back working, plus the $2,000 LLP repayment.
Although there are a lot of assumptions built into each scenario, the point is Jessica pocketed over $6,700 in saved taxes plus the earned interest on that money. If she hadn't used RRSPs, she would have only about $20,000 available to her for education instead of $27,377.
By planning ahead to estimate how much you need for your education, you can estimate your required annual RRSP contributions and use that to estimate your overall tax savings.
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