As part of our RRSP coverage, we asked Clay Gillespie, a Vancouver-based certified financial planner and chartered investment manager, to answer selected reader questions.
Question:
Do I pay taxes only on the gains from RRSP contributions when I withdraw them or tax on the entire withdrawn amount?
Answer:
An RRSP allows you to defer paying taxes on the growth of your retirement savings during your prime income earning years. So, while your investments are in an RRSP, they grow tax-deferred. When you make a contribution to your RRSP, you receive a tax deduction for the amount contributed.
The deduction reduces your taxable income, so the higher your marginal tax rate, the greater your tax savings will be. Upon retirement, you withdraw from your RRSP when you are (presumably) in a lower tax bracket, thus multiplying the overall tax-savings effect.
However, every dollar, whether investment earnings or principal, will be taxed as income when withdrawn from your RRSP.
If you buy a dividend-paying stock outside of your RRSP, the dividends are eligible for a dividend tax credit, which reduces your taxes payable. However, if you hold a dividend-paying stock inside your RRSP you are not eligible for the dividend tax credit. Likewise, when you purchase an investment and it increases in value, you only need to pay taxes on 50 per cent of the growth (capital gains).
However, if you hold the same investment inside your RRSP, you will pay tax on the entire capital gain when you withdraw the funds. Capital losses are treated similarly – if you invest funds outside of your RRSP and you lose money, you may apply those capital losses against any future capital gains; inside your RRSP, however, a capital loss is just a loss.
Therefore, it makes sense to hold your equity-based investments outside your RRSP to enjoy the preferential tax treatment and hold your interest-bearing investments (GICs and bonds) inside your RRSP.
Clay Gillespie, a certified financial planner and chartered investment manager, is a financial adviser and managing director at Rogers Group Financial in Vancouver. The views expressed are those of the author and not necessarily those of Rogers Group Financial, which makes no representations as to their completeness or accuracy.