Exploring Better Alternatives to RRSPs

Lately, a lot of our analysis and writing hovers around retirement and RRSPs. We started with a brief post about Not Blindly Contributing to your RRSP a few months back and continued in March with more elaborate one explaining how we were Dealing with Complex Retirement Considerations. Today we persist with some profound thoughts on the never-ending RRSP versus non-registered debate. You’ll still note our research is not exhaustive as it particularly refers to our personal situation.

Some people feel RRSPs are a government scam to take more of their money thru taxes. Many angry retirees almost consider RRSPs as evil when they realize how much tax they owe at withdrawal. They just forgot all about the juicy tax refunds they received when they deducted their RRSP contributions in the first place. Over the years, these RRSP deductions helped fund a great portion of their retirement stash.

We can view RRSP tax refunds as a loan the government allows you to make to yourself. You only have to remember that you’ll have to reimburse it with interest some day (at withdrawal). If you are in the same tax bracket, the interest rate of that artificial loan will be equivalent to your investment return. If you now fall in a lower tax bracket, good for you, you’ll pay less «interest». Similarly, if your tax bracket is higher, tough luck, you’ll end up paying more «interest» via income taxes.

Dealing with Complex Retirement Considerations

As eluded to in our latest Portfolio Update, Boy! is the Canadian retirement system complex. We recently have been doing some research on retirement planning and will now report our findings here. We won’t cover every possibility as we concentrated on our own situation. It should still give you hints on major points to consider. We’ll remain thorough but try not to lose you in all the details. We suggest you pick up all that applies to your retirement situation and refine other pertinent details on your own from there. At least, our exploration should give you a decent head start.

Our main objectives in all those proceedings in to retire comfortably and to try to provide as much money for our kids and grand kids while we’re alive and not only after we die. From the beginning, we thought that minimizing taxes along the way would be one of the best ways to achieve this. As we discovered, it may not be that simple.

Don’t Blindly Contribute to Your RRSP

Despite my best efforts to plan ahead, everything is kind of happening all at once these days. It’s still pleasant as most of it is positive. The irony is that I will probably have too much time to spare on my leave of absence that kicks off just in a few months. I still wanted to take a moment today to talk to you about RRSPs.

As by all the publicity that we get from financial institutions, it seems like RRSP season is already upon us.

I feel kind of sad when I see a lot of folks rushing to the bank for their last-minute annual RRSP contribution. From my standpoint, here’s the typical scenario. Incited by financial salespeople (I must admit I have a hard time calling them advisors), most people blindly fill up papers to contribute to their RRSP (press hard there’s three copies) because they are told it will be awesome for their finances. A lot of months later (because they take too much time to pay their accountant to file their taxes), they get a RRSP-related tax refund and immediately spend it all away! Ouch!

I think you should at least ask yourself these questions before contributing to your RRSP this year.

Maximizing RRSP vs Minimizing Taxes

Contrary to popular belief, maximizing your RRSP may not always be synonymous with minimizing your taxes. Sure, your contributions will bring down your taxable income in the short run and you probably will get a refund soon, once you file your tax return. But after all is said and done, you may also end up paying more tax.

The good news is that, as far as RRSPs are concerned, fairly simple fiscal planning can go a long way. The key is to compare your present (or contribution) tax level with your probable withdrawal tax level.

Because taxes increase with your income level, ideally, you want to contribute when your income is high and withdraw when it is low. In the same fashion, you want to avoid unnecessary contributions when your income is abnormally lower and limit withdrawals in periods where your income is higher.  

Preparing to Take Assets Out of RRSP

Early in the year, we talked about taking time to think and analyze the possibilities surrounding future withdrawals from our investment accounts. In the initial stage, our reflection concentrated on questions like how? And how much? At this point, we will sadly report that our efforts have not significantly paid off. We have not demystified the 4% rule yet. Neither did we develop or stumble upon a better alternative.

All that analysis still eventually oriented us towards the when?

Too Much RRSP May Equal Too Much Tax

As a result, we recently discovered our RRSP value may be too high and are now considering withdrawing money from it sooner than expected. In that context, it looks like we will deregister an important portion of our RRSPs to avoid future tax problems. Essentially, we discovered that too much money in our RRSPs may result in paying a lot more tax later in life or having a big tax bill attached to our heritage, mostly destined to our lovely daughter.

We will admit having too much money is a good problem to have. But it’s important to start taking measures now to possibly avoid wasting an important chunk of it later. With retrospect, investing more in TFSAs instead of RRSPs would have been a better choice, from a fiscal standpoint at least. Fortunately, it’s not too late for some type of gradual rebalancing.

Our RRSPs grew up faster with larger contributions and higher returns than projected. In that regard, part of the credit can be attributed to our successful DIY investing approach.

Changes in our pension plan conditions also greatly impact our future financial situation. Unfortunately, planning for an early retirement kind of goes against the grain. Consequently, we made very conservative assumptions during the last round of negotiations as initial talks amputated pension benefits by almost half for early retirees like us.  

The final agreement was better or less bad than anticipated, we will only lose about 10% of our retirement payouts. Again, this will probably end up generating additional taxable income later.

With all those factors combined, the perspective of paying more tax during retirement than in active life unexpectedly becomes very probable.

As an example, you can see from the Leaving Money in RRSP Chart that, just a 100K$ portion accumulated in your RRSP today, at 45, could generate a nasty tax bill of more than a million bucks 40 years down the road. RRSPs can be a great tool to avoid paying taxes now as it differs your fiscal obligation. But if your ultimate tax rate is high like in this example at 50%, you might end up paying a big chunk of that deferred tax back.

Now that we know we are going to take money or stocks out of our RRSPs, it’s time to explore related technicalities.

Gradual Transfer to Tax-Friendly TFSA

Let’s briefly get back to how much? Projecting income and corresponding tax levels over an extended period is far from exact science. You can still have a general idea of fiscal implications and take actions that should improve the situation.

Special RRSP Tax Considerations for 2015

For our Canadian readers, after the joy of the holidays comes the joy of …RRSP season!!!

Many may think I’m wacky but I kind of like RRSP season as it often rhymes with investing money and reducing taxes. It’s always a delight for me to torture my brain and find the best way to save as much as possible on taxes.   

My passion for RRSP reasoning will be well served this year as matters are even more complicated due the transition between the conservative and liberal governments.

Doing a thorough analysis would still be a nightmare so let’s limit ourselves to my family’s situation to help grasp some of the implications. I hope it will inspire you to explore your own RRSP tax conditions afterwards and complete all relevant research.

Before we go into the thick of things, I’ll remind you that I am not an investment or tax professional of any kind. The intent of this blog is not to give specific tax-related or investing advice. Before investing yourself, we suggest you to do all necessary research and consult a licensed financial professional if need be.

 

One Major Change

Because of the unusual transition situation, should we increase or reduce RRSP contributions this year? That is the question!

Starting in 2016, the liberals will reduce the middle tax bracket from 22% to 20.5% (for taxable income between $45,282 and $90,563 in 2016). They will also introduce a new tax bracket of 33% for taxable income over $200,000 but this measure won’t affect us with our more modest revenue. 

Boost Your RRSP Contribution With a Short-Term Loan

If you are not able to contribute sufficiently, is borrowing to invest in your RRSP a good strategy?

Repay your short-term RRSP loan with your tax refund

A short-term loan is usually a brilliant idea; you can make a larger contribution to your retirement plan while limiting interest charges.

Towards the end of RRSP season (in February), you can borrow and contribute. You have to make sure to FULLY repay your RRSP loan a few months later when you get your tax refund (in March, April or at worst in May).

This short-term strategy allows you to increase your RRSP contribution without paying too much interest.