investor clinic

# Debunking another RRSP myth Add to ...

Last week’s column about registered retirement savings plan myths generated hundreds of comments online and dozens of reader questions.

Today, we’ll answer three of those questions. I’ve also invited Jamie Golombek, managing director of tax and estate planning with CIBC Wealth Strategies Group, to weigh in.

You wrote your RRSP article assuming all investments would be successful, but in real life people make mistakes. At least in a non-registered account I can apply my capital losses against my gains to lower my taxes, which I can’t do with an RRSP. Isn’t that a big drawback of RRSPs?

No. It’s another myth. With an RRSP there are no taxes on capital gains, so not being able to use your losses is a red herring.

Consider the following example. Say you have \$10,000 in an RRSP – \$5,000 invested in stock A and \$5,000 in stock B. Stock A triples to \$15,000, and stock B goes to zero. Assuming a constant marginal tax rate of 40 per cent, if you withdraw the \$15,000 and pay tax of \$6,000, you’ll have \$9,000.

Now, consider the non-registered scenario. At a 40-per-cent marginal rate, \$10,000 in an RRSP is equivalent to \$6,000 in a non-registered account. If you invest \$3,000 in each stock, stock A would grow to \$9,000 (a gain of \$6,000) and stock B would be worth nothing (a loss of \$3,000). Your net capital gain would be \$3,000, half of which is included in income, resulting in \$600 of tax.

Your net proceeds would therefore be \$8,400,A which is \$600 less than in the RRSP scenario. Notice that the difference is all because of the capital gains tax you would pay in the non-registered account – even after deducting your loss – whereas you would pay no capital gains tax with the RRSP.

Now, it is possible to construct a scenario where it would be better to hold a losing stock in a non-registered account instead of an RRSP – assuming in both cases you also have a non-registered capital gain to offset – but this presupposes that you can identify which stock will lose money. And if you had that ability, you would never buy the stock in the first place.

I have \$40,000 of RRSP room and I am approaching retirement. I make more than \$100,000 annually. Does it make sense to take out a loan in the year before retirement to max out the RRSP, then in the following year (when in a lower tax bracket) to withdraw the full amount, pay off the loan and keep the difference in tax paid between the two years?

“This strategy can work,” Mr. Golombek says, “but it’s highly dependent on your marginal tax rate for the year of contribution versus your marginal tax rate in the year of withdrawal.” By his rough estimate, the strategy could cut your taxes by about 10 per cent if the \$40,000 is contributed in 2016 (assuming \$100,000 of taxable income) and withdrawn in 2017 (assuming your only income is from the maximum Canada Pension Plan and Old Age Security benefits). Keep in mind, however, that you’ll have to pay non-deductible interest on the loan, and the \$40,000 added to your actual income in 2017 could potentially reduce your OAS and the age credit.

“It’s best to sit down with a financial adviser or accountant to model your exact numbers to see if this strategy makes sense for you,” he says. If you can find \$40,000 of your own funds to contribute to your RRSP, that might be a better option because you could then withdraw some of the money gradually each year during retirement, instead of pulling it out all at once to repay a loan – and bumping up your taxable income dramatically for that one year.

Your column indicated that an RRSP produces a higher return than a non-registered account, assuming one’s marginal tax rate doesn’t change. But wouldn’t a tax-free savings account be a better option? After all, TFSA withdrawals are tax-free and don’t affect government benefits such as OAS.

If your marginal tax rate when you withdraw funds from an RRSP is the same as when you made the contribution, the after-tax return of the RRSP will be identical to a TFSA (assuming you hold the same investment in each). If your marginal rate is lower when you make your RRSP withdrawal, the RRSP will have an advantage, and if your marginal rate is higher, the TFSA will win.

“However, you are correct in that RRSP (and RRIF) withdrawals are included in income that determines … benefits such as OAS and the age credit,” Mr. Golombek says.

“In such cases, a TFSA may be the preferred vehicle over the RRSP. In addition, the TFSA provides more flexibility than an RRSP/RRIF since withdrawals are added back to TFSA contribution room the following year. What’s more, there are no minimum withdrawals required from a TFSA, as there would be in a RRIF.”

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