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The Companion Advisor: Retirement Planning
In or out? It depends on what you have

Written by Jamie Golombek, AIM Trimark Investments
A Companion Advisor Article

The issue of how RRSP funds should be invested has never been more complicated.

"Just get it in there" is the phrase often used by financial experts, meaning that if you just make that RRSP contribution today, whether parking it in a short-term vehicle such as an investment savings account or a money market fund, you can decide how to properly invest those funds later on.

Sadly, investors often procrastinate and never book that second appointment with their financial advisor, so their RRSP contribution languishes in low interest paying vehicles for months, even years, before being strategically re-allocated to more appropriate investments to grow for retirement.
While the investment decision should never be rushed, taking the time to properly allocate your RRSP contribution from the start will pay off.

So, how should that money be invested?

The classic advice is that interest-bearing investments such as bonds should always be held inside your RRSP. Equities, which generate 50% taxable capital gains, should be held in non-registered accounts. Naturally, this advice applies only to individuals who actually have a choice.

For Canadians still focused on paying off mortgages, there may be no other funds left to invest other than those inside an RRSP. In that case, holding equities inside an RRSP to maximize growth of retirement savings is an obvious choice. Foreign dividend- paying equities are best held inside an RRSP while Canadian dividend-paying stocks should generally be held outside such plans.

Enhancements to the Canadian dividend tax credit last year have significantly lowered the effective tax rate on Canadian dividends. For example, the top marginal tax rate on Canadian dividends in 2007 in British Columbia is 18.5%, well below the province's 21.9% rate on capital gains. If Canadian dividends are earned inside an RRSP, however, the dividend tax credit is lost and the income when withdrawn is fully taxed at your marginal tax rate. For a B.C... investor at the top rate, this means paying 43.7% tax on this income versus 18.5%.

Effectively, this amounts to double taxation, since a company that pays about 32% corporate tax on its income can only distribute the remaining 68% as a dividend to its shareholders. The math gets worse: If that shareholder is a B.C. resident holding the dividend-paying equity inside an RRSP, she will face a tax of 43.7% on those dividends when withdrawn from her RRSP, resulting in a total tax burden of nearly 62%.

A solution to this problem was recently proposed by tax professor Jack Mintz of the Rotman School of Management. He recommends that RRSPs also be granted a dividend tax credit to ensure that after-tax corporate profits from Canadian corporations are not taxed twice.

Bottom line, you may wish to keep your Canadian dividendpaying equities outside your RRSPs, which is now easier than ever thanks to the elimination of the 30% foreign-content rule, permitting your RRSP to go global.

Jamie Golombek, CA, CPA, CFP, CLU, TEP, is vice-president, taxation and estate planning, at AIM Trimark Investments in Toronto.

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