Nov. 7, 2023
My husband is on sabbatical next year and I am taking eight months off work on an unpaid leave so I can accompany him on some of his travels. I have about $15,000 in RRSP contribution room and I am considering contributing that amount this year (while I am working full-time), then withdrawing it next year to pay for my travels. It seems like a smart thing to do as it will reduce my taxes this year and I will pay taxes on the withdrawal when I am only working for four months next year. I understand I will lose that contribution room in my RRSP account. Is there anything else I should consider? Is this a bad idea? Thanks.
The decision to accompany your husband on sabbatical and take an eight-month unpaid leave from work represents the intersection of two different disciplines: financial and life planning. While financial planning (often conflated with investment management) is more familiar to most Canadians, this idea of life planning begins with the imagination and understanding of what a life well lived means, then aligning your finances in a manner that brings that notion to life.
Your idea to contribute to your registered retirement savings plan and subsequently withdraw from it is clever, but let’s dissect how I would approach planning for such a life event, starting with life planning, as we always do.
The opportunity to travel and experience new cultures and places with your husband is invaluable. Such experiences can offer personal growth, strengthen relationships and create lasting memories. We believe understanding your whys so we can plan for the hows is critical.
Now for the housekeeping items. When it comes to budgeting, I’m uncertain as to whether your husband’s sabbatical is paid or unpaid. Depending on where you find yourself in the world, the cost of life can be dramatically different from what we’re familiar with in Canada.
Let’s also not forget about any existing costs that you might still be responsible for while you’re abroad: gym and social memberships, subscription services and housing costs (such as property taxes). You should also remember to include things such as foreign transaction fees in your budget if you plan on using debit and credit cards with any regularity. It’s possible to avoid those pesky fluctuating currency rates and bank fees altogether with some alternatives such as Wise and KnightsbridgeFX.
Contributing to an RRSP during the year of your full employment can certainly offer tax advantages. If you were to contribute the entire $15,000 to your RRSP in this tax year, it would reduce your taxable income by an equal amount. This could very well position you in a lower tax bracket and put a nice chunk of change in your pocket, thanks to a potential tax refund. Recognizing that your income is higher this year, maximizing your RRSP contribution now and then withdrawing it next year is a clever thought.
When it comes to figuring out how you are to fund your travels, you should consider registered and non-registered sources. Though it’s logical to withdraw from high-tax sources (an RRSP, for example) during low-income-earning years, drawing from tax-preferred sources (non-registered accounts) during normal-income-earning years might serve you better.
There are a few reasons for this: Any RRSP withdrawal results in tax-deferred contribution room and potential future income-splitting opportunities on that withdrawal being lost forever, and so-called tax drag in non-registered accounts. Simply put, returns earned in a non-registered account attract income taxes, which results in fewer dollars invested over time compared with an RRSP.
If an RRSP-only withdrawal is what you’ve determined to do, even though you might be in a lower tax bracket next year because of only working for four months, withdrawals from an RRSP are subject to withholding taxes, and have to be included as total income for tax purposes. These amounts can range from 10 per cent to 30 per cent of the withdrawal.
Depending on how much income you expect to earn if or when you return to work, withdrawing multiple smaller amounts (resulting in less withholding taxes) could be beneficial to your cash flow. However, at the end of the day, because of how income taxes are calculated in Canada, this withdrawal strategy may prove to be of no benefit when taking other income sources into account. In either case, working with a professional to avoid any unwanted tax surprises would be wise.
There are additional factors to consider before departing that might not be so intuitive. It might be wise to get a decision on any and all personal insurance (including travel) applications, identify in advance health care access and treatment coverage, confirm your travel agendas aren’t in conflict with Canadian residency requirements, update your wills and power(s) of attorney, ensure the beneficiaries on your registered accounts are accurate and up to date, and, lastly, if you have digital assets (such as social-media accounts and passwords), ensure their whereabouts are also complete and known by people you’ve trusted.
In conclusion, while the RRSP strategy you’re considering does have its merits, especially in terms of immediate tax relief, the longer-term financial implications and the permanent loss of contribution room need to be weighed carefully.
Before making a final decision, consider consulting with a fee-only Certified Financial Planner professional – one who can offer a tailored analysis based on your complete financial picture, and who doesn’t sell products. Whichever path you choose, prioritize a balance between fulfilling adventures and long-term financial security.
This Globe and Mail article was legally licensed by AdvisorStream.