Updated: Apr 19, 2019
Registered retirement savings plans (RRSP’s) were introduced back in 1957 offering Canadians a fantastic opportunity for tax deferral in their retirement savings. The key word in that sentence is deferral as many Canadians found out when they started to withdraw funds from their RRSP accounts later in life. As a refresher, when you contribute to an RRSP account, your contribution amount can be deducted from your gross income before tax and thus reducing your tax liability for the year of the contribution. When withdrawals are made, the amount of the withdrawal is added to your taxable income in the year it is withdrawn and therefore increases your tax liability. Since that realization was made people have been looking for ways to withdraw their funds from their RRSP’s tax free. So, I have good news and bad news for you as it relates to answering that question. Let’s start with the bad news.
There is no official way that you can withdraw funds from your RRSP tax free. Money that comes out of the RRSP (unless for first time home buyers plan or lifelong learning plan) will be taxed as income. The good news? There are strategies which can create tax neutrality on your RRSP withdrawal meaning that your tax is eliminated by offsetting deductions. Let me introduce you to one such strategy known as an RRSP meltdown.
The purpose of an RRSP meltdown strategy is exactly as it sounds in the name, to withdraw funds from your RRSP over time while limiting the amount of tax to be paid or eliminating it all together. A traditional RRSP meltdown strategy works by utilizing tax deductions from interest charged on an investment loan and matching the corresponding RRSP withdrawal to the amount of interest being paid. By matching the two figures your net tax position will be neutral based on these two figures. Let’s take a closer look at this strategy by the number:
Let’s assume that you borrow $100,000 at an interest rate of 5% per year through a line of credit and invest the proceeds into an income producing portfolio. You will pay interest of $5,000 per year, which will be income tax deductible since CRA allows you to deduct interest charges associated to money borrowed to earn income. Since you will be receiving a tax deduction of $5,000 per year, you could use that deduction against a $5,000 withdrawal from your RRSP account which would trigger $5,000 in taxable income. As you can see, the plan effectively offsets the tax liability of the RRSP withdrawal. If you wanted to withdraw more from your RRSP annually you would need to increase the amount of interest being paid on the investment loan by increasing the amount you have borrowed and investing more. For example, to write off $30,000 of deductions annually you would need to borrow $600,000 for investment purposes using the same 5% interest rate listed above. So right about now you should begin asking me, “what’s the catch?” and you would be right to do so!
To start with, one of the major items which needs to be handled is how the interest on the investment loan is getting paid. For this strategy to really leave you tax neutral and cash flow positive, the investment created from borrowing the funds needs to earn at least 5% per year and pay the interest associated to the loan. If the investment produces less than 5% you will be left cash flow negative and although you will be tax neutral, the negative cash flow could be looked at as another form of tax. Additionally, it is extremely important that before going into a strategy like this you must understand the risks associated with borrowing to invest. The real risk in borrowing money to invest lies in event that the investment portfolio drops in value and the investor gets uncomfortable, sells the investment but is unable to pay off the loan since the investment as dropped below the amount that was originally borrowed. If you are unwilling or unable to stick to a long-term investment plan and accept the volatility that comes with it this is not a strategy which you should consider as undoubtedly investments will eventually have negative years. As mentioned above, even if the investments are positive they may not earn enough to cover the interest being charged and so you should make plans to pay for the interest from alternative sources if this is the case.
I can’t tell you how many times I have been asked about if there are ways to get money out from your RRSP tax free. The truth of the matter is there are no free lunches out there and the program was designed by the government to avoid those types of loopholes. As I have illustrated, there are strategies which can help you to reduce your tax liability, the question becomes whether or not they are worth the risk. In most cases, I would recommend that instead of attempting to cheat taxes utilizing high risk strategies, you would be better off having a well-designed retirement plan which considers the timing of your RRSP withdrawals, in which years they are occurring and if possible make withdrawals in years when you will have lower taxable income and therefore pay less tax on your withdrawals. The only risk in that is failing to plan.
- Grant White, CIM, CFP®
Grant White is an award-winning Portfolio Manager/Investment Advisor at Endeavour Wealth Management with Industrial Alliance Securities Inc. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.
Industrial Alliance Securities Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. iA Securities is a trademark and business name under which Industrial Alliance Securities Inc. operates.
This information has been prepared by Grant White who is an Portfolio Manager for Industrial Alliance Securities Inc. (iA Securities) and does not necessarily reflect the opinion of iA Securities. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered.