Canadian Capitalist » RRSP

A Blanket Ban on RRSP Swaps is a Bad Idea

Canadian Capitalist — Thu, 07 Jul 2011 03:50:15 +0000

In Budget 2011, the Government proposed a clamp down on certain swap transactions between RRSPs and other accounts:

Benefits derived from asset purchase and sale transactions (“swap transactions”) between RRSPs and other accounts controlled by the RRSP annuitant. A swap transaction is a transfer of property (other than a transfer that is a contribution or a withdrawal) between an RRSP and the RRSP annuitant or a non-arm’s length person. Subject to the application of existing anti-avoidance rules, these transfers, when performed on a frequent basis with a view to exploiting small changes in asset value, can potentially be used to shift value to or from an RRSP without paying tax or using RRSP contribution room, as the case may be. An exception will be provided to accommodate transfers from one RRSP of a taxpayer to another RRSP of the taxpayer.

The Budget proposals are aimed at eliminating “advantages” of a swap transaction which are defined as benefits that intend to exploit the tax attributes of a RRSP. However, media reports indicate that some financial institutions are now prohibiting all swaps with RRSP accounts, not just those that run afoul of the new advantage rules.

One hopes that brokers don’t end up issuing a blanket ban on swaps in RRSPs as many did when similar rules were introduced for Tax-Free Savings Accounts (TFSAs). One can skirt a blanket ban on swaps by buying and selling assets separately in two TFSA/RRSP/taxable accounts. But if one or both assets are not liquid (a GIC, for example), a swap may be the only way to exchange assets between a tax-deferred account (an ideal place to hold GICs) and an investment account. At least with TFSAs, one could work around a ban on swaps by withdrawing funds from the account and contributing in-kind during the next financial year. With RRSPs, brokers will be throwing out the baby with the bathwater if they impose a blanket ban on RRSP swaps.

Tax expert Jamie Golombek says the new rules target misuse of RRSPs.

Related Reading:

A Blanket Ban on RRSP Swaps is a Bad Idea is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

PH&N’s take on the investments in a RRSP or outside debate

Canadian Capitalist — Mon, 07 Feb 2011 05:15:07 +0000

A few years back, money manager PH&N put out a report on whether investors should save inside a RRSP or outside. The report, titled, The Retirement Savings Debate: Inside or Outside the RRSP structure, took a closer look at some opinions that it is more efficient to save for retirement outside a registered plan with the federal government reducing the capital gains inclusion rate to 50 percent.

First, the report tackles who should not save inside a RRSP:

It does not make sense for an individual who has a perpetually low annual taxable income to contribute significant funds to an RRSP if their withdrawals in retirement will be taxed at a higher rate than their current tax rate. Such situations are rare, but may arise, for instance, if an individual with significant accumulated unused contribution room from having invested little in RRSPs receives an inheritance close to retirement.

Second, the report examined the after-tax value of savings inside a RRSP and outside for three different asset mixes. It finds that the more a portfolio is tilted towards bonds, the bigger the advantage of saving within a RRSP. The calculations were made for an individual with an annual income of $100,000. The report says that calculations were also done using an annual income of $40,000 and the results were similar but not as dramatic.

The PH&N report also points out a key qualitative benefit of RRSPs that are absent in other vehicles:

Withdrawals from RRSPs are taxed as income. Because of this, individuals who are still working are less tempted to dip into their retirement savings to fund a discretionary purchase.

The bottom line: If you are middle- or upper-income earner, saving for retirement using a RRSP is more beneficial than saving in a non-registered, taxable account. The advantage is even more tilted in favour of RRSPs if you choose to hold the fixed income portion within it.

Related Reading:

PH&N’s take on the investments in a RRSP or outside debate is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

Ranting against RRSPs

Canadian Capitalist — Wed, 02 Feb 2011 03:41:39 +0000

A recent column in The Financial Post (See Were RRSPs a major mistake?, FP, Jan. 19, 2011) by John Newell, a Toronto retiree, makes an amusing rant against RRSPs. The author makes one good point: it doesn’t make much sense for Canadians with little or no income to contribute to a RRSP, especially with the availability of Tax-Free Savings Accounts (TFSAs). But the rest of the arguments are either far-fetched or just plain wrong:

RRSPs have contributed to the growing gulf between low-and high-income families, which is not healthy for a democracy that needs a growing middle class to thrive.

Why stop there? Why not blame RRSPs for global warming, the Russians scoring five quick goals in the World Juniors or the Olympic torches malfunctioning in the Vancouver Olympics?

That leaves Canadian equities, but why on earth would one want them in an RRSP or RIF when one cannot take advantage of dividend tax credits or low rates of capital gains taxation?

Simple. If you are in anything but the lowest tax bracket, a RRSP allows you to (a) defer tax and (b) shelter portfolio earnings from tax. If your RRSP can accommodate the Canadian stock portion of a portfolio, then that’s where it belongs. Why pay taxes on dividends when you have the option of not doing so?

Don’t forget governments can change the rules of RRSPs (or unit trusts) at any time, especially when they claim they will not.

The Government may also change the rules of TFSAs, dividend tax credits or capital gains taxes. We cannot make plans based on what rules the Government may or may not do in the future.

Canadians are smarter than the government and the financial services industry give us credit for. That is why only 55% of Canadians have RRSPs and why we use about 6%of our total contribution space, leaving more than $600-billion of space unused.

If RRSPs are not such a problem after all, why rant against them? It is a bit hard to sympathize with some Canadians bitterly complaining about having too much in their RRSPs. The solution is simple: stop complaining about your taxes, retire early and enjoy your savings.

Related Reading:

Ranting against RRSPs is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

The Advantages of RRSPs over TFSAs

Canadian Capitalist — Wed, 26 Jan 2011 04:09:55 +0000

It is undeniable that Tax-Free Savings Accounts (TFSAs) have unique advantages but I’m somewhat surprised by some recent reports that suggest that a lot of Canadians would be better off contributing to a TFSA instead of a RRSP. These arguments forget to take into account the unique advantages offered by RRSPs.

Defer income taxes

RRSPs allow taxpayers to defer their income tax obligations to a future year. Taxpayers with wildly fluctuating incomes can smooth out their income tax obligations by contributing to a RRSP in fat years and withdrawing from it in lean years.

Income splitting

When one spouse earns a much higher income than her partner, she can take advantage of income splitting opportunities offered by RRSP accounts. She can contribute to a spousal RRSP and get her income taxed at the hands of the lower income spouse. She can take advantage of income splitting available to seniors who withdraw from a RRSP or RRIF. The tax benefits of income splitting can be substantial.

Increase in income-tested benefits

It is true that withdrawals from a RRSP or RRIF may result in a reduction of income-tested benefits. But the flip side is often neglected. Contributions to a RRSP reduce one’s taxable income and increases income-tested benefits such as the Canada Child Tax Benefit.

Here’s an example. An Ontario couple with two children, earning $50,000 each will receive an annual CCTB of $335. If the couple contribute $9,000 each to their RRSPs their CCTB payments will increase to $1,055 per year.

Shelter foreign investments from tax

Investors who hold globally diversified portfolios should hold their US equities and US-listed ETFs in their RRSPs. Dividends from foreign equities in taxable accounts are taxed at marginal rates. US stocks and ETFs held in TFSAs are dinged a 15% withholding tax. When held in RRSP accounts, these assets are sheltered from tax until withdrawal.

Bottom line

Canadians in the lowest tax brackets will almost certainly better off saving for retirement inside a TFSA. And those in the highest tax brackets are almost certainly better off contributing to RRSPs at the expense of TFSAs. It is impossible to say with any degree of certainly whether one account is better than the other for Canadians in middle tax brackets because of uncertaintly over future tax rates. The superiority of TFSAs is certainly not the slam dunk it is made out to be in some quarters.

Related Reading:

The Advantages of RRSPs over TFSAs is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

Tips for Your RRSP Contribution

Canadian Capitalist — Mon, 01 Mar 2010 04:05:50 +0000

Today is the deadline for RRSP contributions for the 2009 tax year. If you haven’t done so already, you have until 11:59 PM tonight to make a contribution. If you don’t have a plan already, your best bet might be to park the contribution temporarily in cash until you have a plan in place.

Like most Canadians, I’ve been suffering from a case of “too much Olympics, too little time”. So, I’m republishing this post that was originally featured on February 14, 2008. Regular programming resumes tomorrow.

Have a plan: It is all too common that Canadians invest in “something” when they scramble to make their RRSP contribution before the deadline. Often, the “something” is an investment recommendation from an advisor that unfortunately results in a potpourri of holdings that turn out to be yesterday’s winners. This year, when investing your contribution make sure that you have a well-defined asset allocation strategy and refuse to invest until you or your advisor comes up with one.
Park your contribution in a money market fund: A RRSP allows you to hold cash but while you wait to develop an investment strategy, invest the contribution in money market funds or cashable GICs. That way, you have the access to cash when you are ready to actually invest but you are earning something on your funds in the meantime.
Ignore the ads: When money managers take out ads showing the excellent past performance of some of their mutual funds, you should remember that a) investors don’t get to earn past performance b) there is no correlation between past performance and future results and c) when retail investors jump on a trend, it is already too late to ride that train. So, this RRSP season, just ignore the glitzy ads and the drooling returns so prominently displayed.
Check out low-fee options: Canadian mutual funds are notoriously expensive. The average MER of a Canadian equity fund is close to 2.5%. The math is simple – the higher the fees, the lower your returns. Fortunately, low-fee funds are available from many boutique money managers whose fees are substantially lower at 1.2% to 1.8%. By paying lower fees, your chances of earning higher returns than average increase substantially.
Don’t hold too many funds: Many investors are under the mistaken impression that the more funds they hold, the better diversified they are. A handful of funds representing different asset classes will provide you with all the diversification you need.
Consider indexing: Index funds simply track a popular index such as the TSX Composite or the S&P 500. Index mutual funds or Exchange-Traded Funds that can be bought and sold like a stock have the following advantages: a) low fees b) tax efficient because their turnover is typically very low c) since the vast majority of funds fail to beat their benchmarks, an index fund is likely to provide you with higher returns.
Tread warily among these investments: In my opinion, it is best to stay away from these investments: principal-protected notes, labour-sponsored venture capital funds, funds that invest in narrow sectors such as biotechnology or energy or materials, funds that invest in narrow geographic areas such as China or India, mutual fund wraps etc.

Related Reading:

Tips for Your RRSP Contribution is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

Don’t rush your RRSP decisions

Canadian Capitalist — Mon, 22 Feb 2010 07:03:30 +0000

The RRSP season will reach a crescendo this week with Canadians rushing in to “buy RRSPs” to beat the March 1, 2010 deadline. Even if you decide to make a last-minute contribution, you do not have to rush your investment decision. If you are new to the RRSP game, you can open a RRSP account with a no-fee institution such as ING Direct, park your contribution in cash and take your time planning your investment strategy. With the strategy in place, you can transfer the RRSP account out of ING Direct at a later date to another institution that offers a wider range of investment products. If you work with an advisor or already have a RRSP account with your local bank, you can instruct them to park your RRSP contribution in cash temporarily.

All too often, RRSP accounts hold a hodgepodge of yesterday’s winners precisely because the annual contributions are invested in the latest ‘hot’ fund or sector or market. It would be better to devise an investment plan and asset allocation strategy first and then pick the products to implement the strategy. An even better strategy would be to then sign up for pre-authorized contributions and avoid the last-minute rush altogether.

In the spirit of the RRSP season, here are selected tips from past years:

Related Reading:

Don’t rush your RRSP decisions is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

Low savings, not RRSP Contribution Limits are the problem

Canadian Capitalist — Tue, 16 Feb 2010 03:14:51 +0000

A recent C. D. Howe report titled, Cutting Through Pension Complexity: Easy Steps Forward for the 2010 Federal Budget, recommends that the Federal Government raise the contribution limit for RRSPs from 18 percent to 34 percent of earned income (and correspondingly, the maximum dollar amount from $22,000 to $42,000) in the upcoming budget. Recommendations such as this makes you wonder which planet the C. D. Howe Institute inhabits. On Planet Earth, contribution room isn’t an issue at all but using up already available contribution room is.

According to Statistics Canada, a mere 31% of eligible tax payers actually made a contribution for the 2007 tax year. The average contribution to a RRSP was $5,412 but the median contribution was only $2,780. The contributions used up just 6.0% of total contribution room available. The data suggests that the vast majority of Canadians have accumulated vast amounts of RRSP contribution room. Only a tiny fraction of Canadians have used up all their contribution room and would benefit from any boost in RRSP limits.

The C. D. Howe report is silent on the fact that the introduction of the Tax-Free Savings Account has already essentially boosted contribution limits to a tax deferred retirement savings account. Joe Canadian, an Ontario resident who earned $80,000 in 2008 would have a 2009 RRSP contribution room of $14,400. Joe can save another $5,000 for his retirement in his TFSA. While the TFSA contribution does not result in a tax deduction, it has roughly the same as effect as contributing another $8,833 to Joe’s RRSP account. If Joe maxes out both his RRSP and TFSA, he is in effect saving 29% of his earned income. The Joes of the world already have plenty of retirement savings room. But boosting contribution room will achieve little in addressing the savings problem of the vast majority of Canadians.

Related Reading:

Low savings, not RRSP Contribution Limits are the problem is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

C. D. Howe’s take on TFSA versus RRSP

Canadian Capitalist — Tue, 02 Feb 2010 04:25:35 +0000

You may want to check out a recent C. D. Howe Institute report titled Saver’s Choice: Comparing the Marginal Effective Tax Burdens on RRSPs. The report concluded that TFSAs are a more tax-efficient retirement savings vehicle than RRSPs for many Canadians because the effective rate of tax payable on retirement income is often higher than that the tax imposed on regular income during working life. To make a comprehensive comparison of effective tax rates, the authors of the report use a metric they call marginal effective tax rate (METR):

The marginal effective tax rate (METR) is the tax rate bearing on an incremental dollar of income, or the next dollar earned. For individuals, comprehensive METR measures take into account the income thresholds and statutory rates of the personal income tax system, as well as the impacts of tax deductions and credits and income-tested federal and provincial benefits.

The authors then compute the difference in METRs between working-life income versus retirement income and produce graphs such as the one shown below (the graph shows the METR delta for a Single, Ontario resident replacing 60% of working life income) for three provinces (Alberta, Ontario and Quebec) and three income replacement rates (80%, 70% and 60%).

The graph confirms our suspicions that lower income Canadians are better off to save for retirement in a TFSA. Recall that withdrawals from a RRSP result in a claw back of the Guaranteed Income Supplement (GIS) boosting the effective tax rate to as much as 70%. On the other hand, withdrawals from the TFSA are not counted in calculations for income-tested benefits handing the TFSA a massive advantage for low-income Canadians.

However, there is a surprise in the findings. The report’s METR comparisons seems to suggest that Canadians in middle tax brackets (such as those Ontario residents earning between $54,000 and $81,000 and aiming for a 60% replacement rate) might be better off saving for retirement in a TFSA.

Unfortunately, I think the analysis, which seems complicated enough, is still too simplistic. What matters in comparing the TFSA and RRSP is not the METR, it is the AETR (average effective tax rate) on contributions to a retirement account and the AETR at the time of withdrawal. Let’s take a simple example. A one-income household with an annual income of $100,000 will likely have a AETR of 43% in their working years. For a 80% replacement rate, the AETR on withdrawals is likely to be 30% or less because (a) due to income from the CPP, most of the GIS is clawed back anyway, whether or not the household receives another dollar of income from a RRIF and (b) income-splitting opportunities that allow the household avoid the OAS claw back. Add children to the mixture and the analysis becomes even more complicated because RRSP contributions will not only result in tax deductions but also increase CCTB payments.

Ultimately, the TFSA versus RRSP question is largely academic because who knows how tax rules, brackets and rates will evolve and change in the future. For now, it seems clear that low-income households can skip the RRSP and save in a TFSA. Everyone else can probably safely cover all bases by contributing as much as they can to both the TFSA and RRSP. If they save predominantly in one vehicle rather the other, they are still likely to come out ahead because what matters most is that they saved for their retirement, not which savings vehicle turned out to be marginally better in retrospect.

You may also be interested in what The Wealthy Boomer and Canadian Financial DIY have to say on the topic.

Related Reading:

C. D. Howe’s take on TFSA versus RRSP is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

In-Kind Contributions and Superficial Loss Rules

Canadian Capitalist — Tue, 24 Feb 2009 12:38:45 +0000

If you hold securities in a taxable portfolio, you can contribute them in-kind to your RRSP. But, you have to keep in mind the tax implications because an in-kind transfer is considered as a deemed disposition. If you have capital gains, you’ll have to declare it in your tax return. However, you cannot claim a capital loss on an in-kind contribution.

I was under the mistaken impression that you could simply sell the security in your taxable account, claim the capital loss and then buy the same security in your RRSP account. Turns out that the Canada Revenue Agency changed the rules in March 2004 and superficial loss rules will apply if you do that. Here’s the relevant portion from the Capital Gains Guide (T4037 Rev.08):

A superficial loss can occur when you dispose of capital property for a loss and:

you, or a person affiliated with you, buys, or has a right to buy, the same or identical property (called “substituted property”) during the period starting 30 calendar days before the sale and ending 30 calendar days after the sale; and

you, or a person affiliated with you, still owns, or has a right to buy, the substituted property 30 calendar days after the sale.

Some examples of affiliated persons are:

you and your spouse or common-law partner;

you and a corporation that is controlled by you or your spouse or common-law partner;

a partnership and a majority-interest partner of the partnership; and

after March 22, 2004, a trust and its majority interest beneficiary (generally, a beneficiary who enjoys a majority of the trust income or capital) or one who is affiliated with such a beneficiary.

Bottom line: If you hold a security in a taxable account and have a significant capital loss, you may want to sell the security, lock-in the capital loss and buy an equivalent security (that is not “same or identical”) inside the RRSP.

Thanks to Canadian Financial DIY for a detailed post on this topic.

Related Reading:

In-Kind Contributions and Superficial Loss Rules is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

Reader question on transferring a RRSP account

Canadian Capitalist — Tue, 12 Aug 2008 04:07:18 +0000

Today’s question is from Christine:

How can I move a self-directed RRSP account from my broker to a self-directed RRSP account with TD Waterhouse?

It’s quite simple to transfer a RRSP account between different institutions — look for a transfer authorization form from the institution you want the account transferred to (the TD Waterhouse form for transferring a registered account can be found here). The form is fairly self-explanatory but the key decision you have to make is whether to transfer each security in-cash or in-kind. When an in-cash transfer is made, your investment will be sold and the proceeds transferred to the receiving institution in the form of cash. In-kind means the account is transferred as is, without any changes to the extent possible (it may not be possible to transfer some securities such as TD e-Series funds to another institution). Note that if you request an in-cash transfer of taxable accounts, you may be on hook for capital gains taxes.

As you could probably guess, a transfer out fee is charged by the institution you are transferring out of. TD Waterhouse, for instance, the transfer out fee is $125 plus applicable taxes. If your account is large enough, the receiving institution could agree to refund the fee. So, be sure to call and ask for a refund before you initiate a transfer. If an agent agrees to a refund, write down the name of the agent and don’t forget to follow up and call in the refund request once the transfer is complete.

Also, dividend payments received in the old account after a successful transfer will be moved later automatically.

Related Reading:

Reader question on transferring a RRSP account is brought to you by Canadian Capitalist -- Helping you to invest & prosper.