The Companion Advisor:
Is the RRSP dead?
With the recent reduction of the capital gains inclusion
rate to 50 percent from 75 per cent, many advisors and their clients are
asking themselves the question: "Is the RRSP dead?".
The problem, according to skeptics, is that funds withdrawn
from an RRSP (or its successor, as RRIF) are included in income at the
withdrawing annuitant's full marginal tax rate at the time of withdrawal.
In addition, any withdrawals are taxed as straight income notwithstanding
the fact that they may have been the result of Canadian dividends or capital
gains earned inside the registered plan.
For example, if capital gains were earned inside an
RRSP or RRIF, and are subsequently withdrawn by the annuitant, they are
re-characterized as income. Therefore, the annuitant is taxed at full
tax rates applicable to ordinary income instead of the reduced 50 per
cent inclusion rate generally applicable to capital gains.
Now, let's assume that instead of contributing funds
to an RRSP each year, we invest the same amount of our RRSP contribution
in a non-registered (open) account which holds a mix of equity investments.
Upon ultimate disposition, any profits earned on those investments would
result in capital gains to the investor, taxable at only 50 per cent of
the investor's marginal tax rate.
As a result, some advisors are concluding that perhaps
it makes sense to stop contributing to an RRSP and instead, redirect that
money towards a non-registered equity investment where the ultimate returns
would be in the form of tax-advantaged capital gains as opposed to fully
taxable registered plan withdrawals.
I'd like to suggest, however, that the RRSP is still
the preferred investment vehicle for several reasons. First, the RRSP
or RRIF offers unlimited tax deferral until the funds are withdrawn. In
an RRSP or RRIF, the annuitant can choose to rebalance his or her portfolio
as appropriate. If gains have been realized on some of the investments
inside the registered plan, these gains remain tax sheltered as assets
are reallocated from one asset class (e.g. equities) to another class
(e.g. bonds). This gain is deferred indefinitely until the funds are ultimately
withdrawn from the registered plan. Let's contrast that to a non-registered
While it is true that no tax is generally payable on
an equity investment until that investment is sold, how many clients are
prepared to buy and hold an individual security or fund for 20 or 30 years?
Such an argument, therefore, while in theory may sound great, is probably
not practical in real life, as an investor may be reluctant to dispose
of a property that has gone up tremendously in value because of the potential
for large capital gains tax on such a rebalancing.
This may have the added effect of discouraging a reallocation
of the investment mix where such a reallocation may be the appropriate
thing to do for the client because their risk tolerance profile has changed
as they approach retirement age.
Secondly, and most importantly, the RRSP offers a tax
deduction in respect of contributions made. For example, someone in a
marginal tax bracket of 45 per cent would get back $4,500 for a $10,000
RRSP contribution. If the tax refund received from making a contribution
is continually reinvested annually in a non-registered account, after
several years the value of this investment will more than compensate for
the fact that the corresponding RRSP investment will be taxed at full
marginal rates upon retirement.
Finally, the RRSP offers, for many Canadians at least,
a psychological motivation to invest for their retirement on a regular
basis. If investors can manage to invest at least the legal maximum RRSP
contribution limit (18 per cent of their prior year's earned income -
generally employment income, rental income, etc. - up to a maximum of
$13,500 less any pension adjustment), then they will be a long way towards
a financially healthy and secure retirement.
While we have encountered come situations where perhaps
ceasing to make RRSP contributions makes the most sense, it would generally
only be limited to specific cases. Factors to look at that may lead you
to reach this conclusion include cases where:
· You have already accumulated a significant
amount of assets inside your registered plan;
· You are approaching the age at which you will
begin withdrawing from the plan, and
· You expect to be in a higher tax bracket when
withdrawing funds then you may have been in when the RRSP deduction was
It is important to sit down with your financial advisor
and work through the numbers to determine whether or not you should indeed
stop contributing. However, in most cases, bearing in mind the factors
above, I think you will find that the value of the reinvested RRSP tax
deduction far outweighs the benefit of the potentially lower capital gains
tax in a purely non-registered investment program.
This article first
appeared in the July 2001 issue of Forum Magazine.
Jamie Golombek, CA, CPA, CFP,
is Vice President, Taxation and Estate Planning at Aim Funds Management
Inc. He provides internal consulting on all areas of taxation and estate
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