RRSP Exit Strategy

What’s your RRSP exit strategy?

For Canadians, RRSP’s have been a great avenue for tax deferral for many years. So when in comes time to withdrawal and/or unwind from your RRSP how can you do it the most tax advantageous way? If not done properly you will certainly lose most if not all of the tax benefits that you gained from investing for all those years.

This article will outline some strategies that will keep some of the tax dollars that you deferred in the past in your pocket.

Before we get into the strategies it’s important to note that there is always a tax liability on retirement income (including your RRSP savings). It’s treated in most respects like regular income. When unwinding your RRSP there is also a minimum requirement that must be taken out every year. This minimum amount may be more than you need. RRSP’s can also be passed between spouses in a tax-free rollover. There are also special rules for RRSPs left for dependant minors or disabled beneficiaries.

On to the strategies!

1. Asset allocation

This strategy is to eliminate any capital gains/dividends within the RRSP. Since these assets provide a more favourable tax liability outside of a registered account, consider putting these assets in non-registered accounts. Capital gains arising from stocks, funds, mutual funds that hold stocks, dividends bearing Canadian stocks are some examples of assets that should not be held in your RRSPs. The reason for this is that capital gains held in a non-registered account get a 50% deduction for taxes. Canadian dividends receive a federal dividend tax credit provided that they are not in a registered account. Capital gains and dividend benefits fall by the wayside and are taxed at the highest marginal rate within a registered account.

Things that should go into your RRSP are all interest-bearing assets. These are going to be taxed at the highest rate no matter what, so they might as well go into an RRSP and receive the benefits that they provide. Interest bearing assets include cash, treasury bills, GIC’s, commercial paper, money market funds, and bonds.

Here is an example of what we are talking about:

Capital Gain – $100,000

Non-registered tax liability Registered tax liability
Approximately $23, 200 Approximately $46,400

The amount is double because you don’t receive the 50% capital gains deductions for distributions within an RRSP.

2. Tax bracket management

This strategy involves effectively managing your tax bracket when taking income from your RRSP. As you can imagine, this take some discipline on your part. This strategy is best seen through example.

Let’s consider that in your retirement you need $45,000 to live comfortably. For 2011, for incomes between $41,514 to 61,544 the marginal tax rate is 31.15% (Ontario). This means that your whether your total income is $41,514 or $61,544 you will be taxed at the same rate. To effectively remove money out of your RRSP you should consider removing an additional $16,544 because it’s taxed at the same rate. On the additional income of $16,544 you’ll pay $5,153 as opposed to $7678 (at the highest rate), a saving of $2,525. With the extra cash you withdrew you can reinvest it into a TFSA (tax free account) or some other non-registered account.

Remember that OAS clawback begins at $67,688 in 2011.

3. Permanent insurance

When considering one of the best ways to pass on your RRSP/RRIF upon death consider using permanent insurance. As permanent insurance passed upon death is tax-free consider how this can be used in your portfolio. Permanent insurance uses concepts from tax bracket management in that if you consider the extra $16,544 that you withdrew from your RRSP/RRIF and use it to fund a term 20 insurance policy with a cash value. The after tax value leaves a significant tax savings for your estate and beneficiaries.

What is important about these strategies, for any RRSP/RRIF strategy (yes there are more!), is the recognition that simply putting your money into RRSP with no exit strategy is not beneficial. A good RRSP/RRIF strategy with the proper understanding of your tax rate will save you and your estate money.

If you like any further clarification about this topic drop us a line at info@canamtax.com.