# RRSP/ TAX- let the games begin!



## indexxx (Oct 31, 2011)

I'm starting to question the value of my RRSP as a moderately low-income earner, so here's a two part question. 

1.Would this be advantageous? Say you had a chunk of change in an RRSP, for our purposes say $100,000. Being that we all want to minimize the tax bite and maximize returns, does it make sense to withdraw your RRSP before you retire and re-invest it in a lower-tax attracting vehicle such as dividend stocks/ capital gainers outside a shelter, in order to minimize clawbacks?

2. You have $100,000 in an RRSP. You foresee full income taxation on collapse at retirement- but what if you withdrew it several years prior to retiring, in a low-income year, like if you took six months off to travel? Could you not pay much less tax on it due to the lower marginal rate, and invest the difference in a more tax-favourable way such as dividends/ capital gains outside an RRSP?


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## MrMatt (Dec 21, 2011)

1. Maybe, but remember you pay tax when you withdraw, then on any further gains. In addition the dividend gross up outside can have an effect.

2. Yes, and you should balance your incomes to pay a lower tax rate. The thing is if you are making investment gains it might not make sense.


Why tax deferal matters, assume 30% tax rate, 50% inclusion rate for capital gains, 100% return starting with $1000 in RRSP.

$1000 in RRSP, doubles = $2000 in RRSP, withdraw, pay $600 tax, leaving you with $1400.
$1000 in RRSP, withdraw paying $300 tax, leaving you with $700, double your investment is $1400, pay tax (capital gains) of $105, leaving you with $1295.

RRSPs (and TFSAs) are great for compounding returns. To make RRSPs less attractive you have to play with the marginal tax rates.


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## Four Pillars (Apr 5, 2009)

indexxx said:


> I'm starting to question the value of my RRSP as a moderately low-income earner, so here's a two part question.
> 
> 1.Would this be advantageous? Say you had a chunk of change in an RRSP, for our purposes say $100,000. Being that we all want to minimize the tax bite and maximize returns, does it make sense to withdraw your RRSP before you retire and re-invest it in a lower-tax attracting vehicle such as dividend stocks/ capital gainers outside a shelter, in order to minimize clawbacks?
> 
> 2. You have $100,000 in an RRSP. You foresee full income taxation on collapse at retirement- but what if you withdrew it several years prior to retiring, in a low-income year, like if you took six months off to travel? Could you not pay much less tax on it due to the lower marginal rate, and invest the difference in a more tax-favourable way such as dividends/ capital gains outside an RRSP?


From your comment, I'm wondering if you think you have to collapse the RRSP in retirement?


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## indexxx (Oct 31, 2011)

Four Pillars said:


> From your comment, I'm wondering if you think you have to collapse the RRSP in retirement?


I meant that at age 71 you have to start withdrawing the funds.


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## Eclectic12 (Oct 20, 2010)

indexxx said:


> I'm starting to question the value of my RRSP as a moderately low-income earner, so here's a two part question.
> 
> 1.Would this be advantageous? Say you had a chunk of change in an RRSP, for our purposes say $100,000. Being that we all want to minimize the tax bite and maximize returns, does it make sense to withdraw your RRSP before you retire and re-invest it in a lower-tax attracting vehicle such as dividend stocks/ capital gainers outside a shelter, in order to minimize clawbacks?
> 
> [ ... ]


The clawbacks are based on net income - which includes different income types such as investments as well as RRIF withdrawals. 

For option 1 - If the RRSP withdrawal/convert to taxable investments has had the effect of converting the RRIF withdrawal amount into the same amount or more of income in a taxable account - a clawback will likely still be triggered. 

Then too - dividends are grossed-up so that the amount received is less than the amount reported on the tax form (see link where in 2006, $1K dividends received is reported as $1450 income).
http://www.milliondollarjourney.com/how-investing-taxes-work-part-2-dividends-and-interest.htm

In this situation, the question becomes what advantages are there to paying the tax on the RRSP withdrawal and then on the investments "as-you-go" versus allowing the full gains to be re-invested/grow until withdrawal.

Note that there are other factors such as retirement date and income (ex. retire at 55 on an income 60% of today's with no CPP yet - may also help for RRSP withdrawals).



Option 2 works well, as long as one can control the other sources of income at the time of the RRSP withdrawal.


Cheers


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## indexxx (Oct 31, 2011)

My thoughts on #1 were: if you sold off and withdrew your 100k prior to turning 65, paid the 30% (or whatever marginal rate applies), and either 

A. stuck it in the bank to draw from, thus assuring yourself of no clawbacks on CPP/OAS as the money is not income, or

B. sold and withdrew, paying the 30%, and plowed it into Canadian dividend payers, maybe making $3- $4000/year and getting the low tax rates on that income, you 

So instead of being forced to withdraw X amount per month through an RRIF or an annuity, thus losing a significant portion of government monies through clawback, you withdraw your RRSP early, still have that money to draw from (or to produce a moderate dividend stream that attracts low tax), and still get your old-age benefits.

This then raises another question; why use an RRIF that will be counted as income against clawbacks? Why not just cash in your RRSPs and have the money in a bank account to withdraw as cash instead of income? Of course you'll pay the marginal rate on the whole amount upon withdrawal, but you will never incur clawbacks. It seems better than using an RRIF, paying the taxes on withdrawal as you go (which will amount to the same amount in tax as cashing out lump-sum), and also being subject to clawback, dissolving a significant portion of your gains over time.

The reason I'm asking these questions is that I've seen a lot of articles stating that RRSPs can be a poor choice for some people, and I have some of my retirement funds in an RRSP.


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## Eclectic12 (Oct 20, 2010)

indexxx said:


> My thoughts on #1 were: if you sold off and withdrew your 100k prior to turning 65, paid the 30% (or whatever marginal rate applies), and either
> 
> A. stuck it in the bank to draw from, thus assuring yourself of no clawbacks on CPP/OAS as the money is not income, or
> 
> ...


Your thoughts seem to depend on assumptions that may or may not be true in different situations.

The way I read your posts, some key assumptions are that: 
a) RRIF withdrawals will automatically raise retirement net income to be high enough to trigger a clawback (depends on situation).
b) Withdrawing from an RRSP will assure that the net income will be low enough to avoid the clawback (depends on situation). 
c) dividends are taxed at a better rate so that the net income rises more slowly likely minimizing a clawback ($4K dividends paid is grossed up to something like $5.6K then added to Net Income, so the increase can be more than expected).

Each person's situation varies so how do you know that you fit the assumptions/profile from the articles? 

Have you run some scenarios to confirm:
a) what your retirement income might look like, including investment income?
b) that the RRIF withdrawals based on what you think your RRSP grows to will generate are enough to trigger a clawback?
c) that an RRSP withdrawal is enough to change the situation?

After all, the original info that recommended contributing to an RRSP also made assumptions that you now don't believe will apply to you.


As for the "why use a RRIF", a couple of possibilities are the individual:
1) doesn't have a choice.
2) has RRIF amounts are too small to trigger a clawback.
3) was already a high income earner (i.e. clawback either way so that the RRSP enables tax deferred compounding).

As for the "RRSP withdrawn to a bank account = no clawback", hopefully it is clear that this *may work or it may not*. Even if it works most years, all it would take is a stock sale in a taxable account for a large enough capital gain. The CG is included in the net income goes up and can also trigger the clawback.


The bottom line is that the clawback is from the net income level, regardless of whether an investment, a RRIF or pension puts the total over the threshold.



Cheers


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## Four Pillars (Apr 5, 2009)

+1

Some great points from Electic.

@indexxx - which clawbacks are you referring to? GIS or OAS? 

Doing an rrsp meltdown to avoid GIS clawbacks can often make sense. OAS is not as clearcut.

One thing to remember about OAS clawbacks is that they don't kick in for a couple (because of income splitting) until their income is about $140k. This doesn't affect a lot of people.


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## Eclectic12 (Oct 20, 2010)

Four Pillars said:


> +1
> 
> Some great points from Electic.
> 
> ...


Thanks.

To be clear - my concern is making a choice without appropriate due diligence. It's great to have the article(s) stir up questions but "looking before you leap" can often repeats mistakes. Each action is appropriate in different situations so the starting point IMO is for the OP to determine or make educated projections of their situation.

It's also good to know about the income splitting for couples ... now I just have to get married to take advantage of it ... *grin*


Cheers


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