We just did some preliminary tax calculations and thanks to carried-over tuition/education amounts from previous years, and our RRSP contributions from last year, we will be getting a tax refund of around $9500. Sorry you can’t “act now to receive my amazing tax secrets.” We just had a lot of tuition credits to use, but we have now used up all our tuition/education amounts so that will be the last time we have that kind of a refund. We will either be putting that refund into our RRSPs, then reducing our monthly RRSP contributions over the next 12 months, thereby increasing the amount we can put down our student line of credit each month, OR putting it down on the line of credit thus reducing the amount of interest we have to pay on the loan each month, thereby increasing the amount of principal paid each month. Either way, it doesn’t really matter too much. I figure the risk-adjusted return on the RRSP compared to the line of credit is about the same. Although the student line of credit is at prime so the return there is really low.

I don’t know what your particular employment situation is, but from my perspective, the idea of getting a large tax refund at the end of the year due to the fact that I’ve made RRSP contributions over the course of a year really amounts to an acknowledgment by CCRA that I have over-paid taxes and that they owe me money. It is effectively an interest-free loan to the government of the refund I am due.

I would prefer to have that money now rather than later. Therefore, every year, what I do is complete a CCRA form called “T1213 Request to Reduce Tax Deductions at Source”. I simply provide evidence to CCRA to prove that I am making periodic RRSP contributions, and they provide authorization to my employer to reduce the amount of taxes that are subtracted from each paycheque. As a result, over the course of the year, I receive my “tax refund” every 2 weeks, rather than having to wait until March or April of every year. What’s more, I can immediately take the savings from my paycheque and invest it into an RRSP, therefore increasing the time during which the investment compounds, etc.

Just a tip.

We did that once because we really needed more money every month. We showed proof of tuition credits and RRSPs and paid no tax. The annoying part is that you have to do it every year. The other tricky part is that you have to actually do the same thing with the extra cash you get every paycheque that you would do with the large refund. For us, we’re more likely to invest the tax refund but if we got a little bit more every paycheque it might get invested but some of it might end up going into other savings accounts. Many people refer to the government’s tax collection as a bit of a forced savings plan and I tend to agree with them.

That’s a HUGE refund. Was it all from tax credits, or did you actually pay a lot of tax during the year (which would be worse, right)?

We each had about $9000 in taxes taken off our paycheques. It was basically all from education credits and RRSP deductions.

What is the interest on your LOC? It probably floats and is 6% or so. The return you are getting from that $9K is after tax – assuming you are in the highest marginal tax bracket in Ontario, that means your pre-tax return would need to be around 8.75%.

Now, adding the $9K to your RRSP gives you a tax-free return (assuming you are putting it in to a well-diversified pool of funds, equities, fixed income, you may get) of maybe 9%. However,you also get a tax refund on the $9K – if you are in highest tax bracket in Ontario, 45% -that really boosts the attractiveness here. Of course, putting the $9K in your RRSP is more risky than the zero risk paydown of debt. But, given that you are already paying into your RRSP – and assuming that you will not reach your contribution limit – putting the money in your RRSP may be the way to go.

The relative attractiveness of the RRSP option diminishes as the LOC interest rate increases…and increases as the expected return of your RRSP increases.

You’re right, it is set exactly to prime and moves around and is at 6% right now. They are supposed to convert it to a normal loan now (instead of a student loan) so that might change.

I’m not sure that you can just take a percentage and multiple or divide by 1 minus the marginal tax rate to get a post- or pre-tax return respectively. See this long discussion here: “The Home Buyer’s Plan.

Our situation might be a bit easier to analyze as we are going to be contributing the maximum to our RRSP over the next year. So for the $9k we should compare between putting it towards the principal of the loan or putting it in a non-RRSP investment. Yeah the situation would look a bit different if we put it the RRSP now and then we make the choice of what to do with our monthly contributions (that no longer need to go so much towards the RRSPs because of the $9k helper). But it would simplify the calculations if we assume our RRSP will be maxed and the RRSP tax refund has to be invested in a non-RRSP account or the LOC.

For the $9k in non-RRSP case… Here you can multiply the rate of return by some factor since it’s the capital gains and dividends being taxed. Can’t remember the formula for dividend and capital gains right now and they seem to have changed a lot since I last had to declare capital gains and dividends! With these post-tax dollars I’m going to get taxed again on the capital gains and the dividends. With the loan I won’t get taxed but the return is lower (at much lower risk).

I would probably go for paying down the LOC rather than putting the $9k in a non-RRSP investment. If it was a non-RRSP investment it would probably be low-risk because we would probably use it towards a down payment or something in a few years. Capital preservation would be important. Not sure if I can get much better than 6% (at almost no risk).

I hope this post makes sense. I wrote it quickly.

Your analysis of the choice between a non-RRSP investment and paying down your LOC makes a lot of sense; I totally agree. I too would take the money and put down on the LOC, to get a risk-free after tax return of 6%.

Now, in terms of the % calcluations I did – they are ballpark estimates – to illlustrate the principle; here is a hypothetical example with numbers:

Investment Capital: $100K

Pre-Tax Return: $10K or 10%

Post-tax return or “effective” or “tax-adjusted” return (assumes 45% marginal tax rate): $5500 or 5.5%

So, to get the 5.5% after-tax return on 100K invested, you would need to earn $10K, assuming a 45% marginal tax rate.

Tim

Dave – one other thing with your LOC. If you have an asset to secure the LOC, you can get a better rate. You would have to have the asset’s value assessed….but, crunch the numbers and see if it is worth it.