How Your RRSPs Could Ruin Your Retirement

1. How Your RRSPs Could Ruin Your Retirement
All those idyllic beaches, beaming retirees and washed-up superheroes on your TV
screen can mean only one thing: RRSP season is close at hand.
Truth is, if you're a high-income earner who favours a portfolio packed with
higher-risk, higher-return equities, putting money into RRSPs doesn't make sense
at all.
RRSPs have their drawbacks for business owners and entrepreneurs as well!
On Oct. 18, 2000, Paul Martin brought down the mini-budget and cut the capital-
gains tax rates for the second time in a year. This absolutely tips the scales in
favour of non-registered portfolios.
Canadians are now taxed on just half of their capital gains, down from 75% the
year previous to the budget. Now, of course, gains within your RRSP aren't taxed
at all — until you begin withdrawing from your plan, when RRSP savings are taxed
as regular income.
Since many entrepreneurs will find themselves in the top tax bracket upon
retirement, they'll have to surrender almost half their RRSP's value to the taxman!
Meanwhile, holders of non-registered portfolios benefit from the lower tax rates on
capital gains.
Let's use a fictional investor to illustrate this point.
Heather, 40, runs a successful call centre in Ontario that pays her enough to
qualify for that province's highest marginal tax rate: 46.41%. She begins investing
$10,000 a year in an RRSP comprising equities and equity mutual funds.
Each year, she sells 25% of her portfolio and reinvests it all. Assuming annual
returns of 10%, her portfolio will be worth about $1,082,000 by the time she
collapses it at age 65. Not bad for 10 grand a year.
But wait: if Heather converts the whole portfolio into cash and takes the resultant
46% tax hit, she's left with around $580,000. Sure, she'll likely move her pre-tax
portfolio into a post-RRSP shelter, tapping it as her budget requires. But even if
she pulls out amounts small enough to drop her tax rate to 33%, her after-tax
portfolio will be worth just $757,000.
Now watch how well her unregistered portfolio performs. Even though Heather has
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2. to pay her marginal rate on half of her realized capital gains each year, after 25
years her portfolio will be worth $992,000. But even if Heather cashes in the whole
lot, she pays tax on just half of her capital gains.
Her final balance: $850,000 and she still has the option of selling her portfolio
more slowly to cut her tax bill even further.
Caution: RRSPs are not all downside. Since the taxman treats all interest income
equally, your interest-bearing investments will pay more within an RRSP.
(Sheltering your interest-bearing portfolio while holding equities outside your RRSP
is a good option.)
There's also the generous tax break on your annual RRSP investments. Over 25
years, Heather's RRSP contributions cut her tax bill by $116,000 — but still not
enough to close the gap with non-RRSP returns.
However, entrepreneurs need fast access to capital for business emergencies,
which fixed-income investments and RRSPs don't provide. The owner-operator
definitely should have cash that they can get their hands on pretty quickly that
they're not going to have to pay 50% tax on.
They might have opportunities to invest in their businesses that would be
unavailable if they put their money in RRSPs, and which would represent higher
potential returns than would investing in an RRSP.
If you want to start moving funds out of an RRSP, here’s a way to minimize the
hit:
Borrow $100,000 and invest that. Assuming and interest cost of 8%, it's going to
cost you $8,000 a year in interest, [which is] tax-deductible, to borrow that
money. Take $8,000 out of your RRSP every year, [which is] fully taxable,
cancelling it with the deductibility of the interest on the loan.
You're actually taking $8,000 a year out of your RRSP tax-free to pay the interest
on the money you borrowed for an investment outside your RRSP. So you have
$100,000 of someone else's money that's invested for you, and it's not costing you
anything.
Of course, low capital-gains taxes might not last forever. Then again, who says the
RRSP tax credit will stick around?
(It's kind of interesting that the national debt is equal to the amount of tax owed
on deferred registered retirement and pension plans. It's not that I'm paranoid...)
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3. Your next step
Contact us for your personal and confidential “tax busting” appointment!
Phone: 604-207-9970
Email: askmark@WeSaveYouTaxes.com
Who Is Mark Huber?
Mark Huber, CFP, Author
Mark Huber is a practicing certified financial planner (CFP) with over 22 years of
experience in the industry.
Mark’s boutique planning practice works with a select group of clients who are all
share a passionate vision for creating true wealth and living their dream lives.
Mark has made powerful and innovative tax reduction, cash flow and mortgage
reduction strategies core disciplines in his successful practice and also the core
wealth creation process for his clients.
Contact Information:
Mark Huber, CFP
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4. SetForLife Financial Services
8380 Ash Street
Richmond, B.C. V6Y 2S3
Office Tel: 604-207-9970
Office Fax: 604-207-9971
E-mail: askmark@WeSaveYouTaxes.com
Suite 2050-1050 West Pender Street
Vancouver, B.C. V6E 3S7
Office Hours are Monday-Friday
9:30am to 4:30pm PST.
Or "by appointment"
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As with anything involving investments and investing strategies, you agree to
always consult with your professional adviser before making any investment
decisions.
Use this information at your own risk. Be responsible! Always do your own
due diligence.
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