It is important to note the difference between an RRSP “contribution” and an RRSP “deduction”. You “make a contribution” by putting money (or securities) into your RRSP account. You “claim a deduction” when you want that contribution to reduce your earned income on a tax return (to reduce your tax bill and get a refund).
You may already know that you can carry forward contribution room – so if you didn’t maximize your RRSP in any given year, you have the ability to make up for it later. But a lesser known fact is that you can carry forward your RRSP deduction as well.
The RRSP deduction is generated when you make an RRSP contribution, and the norm is to claim it in the same tax year you made the contribution. This is why you get your refund.
If you make an RRSP contribution but don’t use the RRSP deduction, you can carry forward the deduction indefinitely as well. Of course your question now is: Why would I want to do something like that!?
Answer: You expect to be in a much higher tax bracket in the next few years.
Let me explain by using an example. Let’s assume that you make an RRSP contribution of $1,000. If your marginal tax rate is 20% for that tax year, you will generate a $200 refund if you claim the RRSP deduction for that year. But if you know that you will be in a higher marginal tax bracket the following year, say 40%, then you could wait to use the deduction until that time and get a $400 refund. That is essentially a 100% guaranteed rate of return on that money. (Kudos to Ledtim for catching the previously incorrect 50% rate of return stated.)
A word of caution: it doesn’t always make sense to defer the deduction if you are just waiting for a slightly higher marginal tax bracket year OR if the amount of time before claiming the deduction is too great. For example, if the difference between tax brackets is 5% but you won’t be into the higher tax bracket for 5 years, the smaller refund (assuming it is re-invested) doesn’t have to earn much growth for it to make more sense to claim the deduction now and invest the proceeds. Using our $1000 contribution and the 5% difference in tax brackets in 5 years: $1000 contributed might earn $300 (in a 30% tax bracket) now versus $350 in 5 years (35% tax bracket). Your $300 will have to earn $50 in growth over 5 years in order for it to make more sense to claim the deduction now (which can be accomplished if you can earn 3.13%/year after tax).
*Thanks to reader Sam for pointing out my mistaken example earlier.
Please make sure to get an analysis done by a professional for your own situation!