Feb 10, 2017
Personal Investor: Prevent your RRSP from becoming a tax trap
By Dale Jackson
Canadians love registered retirement savings plans (RRSPs) because they can deduct their contributions from their taxable income in any given year.
Governments really love RRSPs because they can delay that tax charge until the contribution grows over the years, and tax the entire amount when it is withdrawn. Outside of an RRSP, only half of the gains on stocks are taxed and dividends can generate a tax credit. Inside an RRSP they are fully taxed.
Having too much money in an RRSP is a good problem to have but withdrawing too much could put you in a tax bracket equal to, or higher than, the tax bracket when you contributed. Even worse, as of this year any income over $75,000 will result in an Old Age Security (OAS) clawback.
One tax-saving option is to take less out of your RRSP but by the time Canadians turn 71 years old, they are forced to convert their RRSPs into a registered retirement income fund. A RIFF is just a new name for your existing RRSP – same tax shelter, same holdings - but instead of money going in, money comes out.
Another big difference is RRIF holders are required with withdraw minimum amounts based on the total amount in the fund and their age, or their spouse’s age. If those amounts are too high, much of the retirement money you saved and risked over all those years will go to the government.
There are ways to avoid having too much money in your RRSP before it’s too late. One includes diverting contributions to your tax free savings account. There’s no tax break on a TFSA contribution but you are never taxed on withdrawals. You can withdraw from your RRSP in a lower tax bracket and top it up with your untaxed TFSA.
High-income spouses can also contribute to a spousal RRSP in the name of a low-income spouse – and shift retirement income to the lower tax bracket.
In retirement, spouses can split pension income and homeowners have the options of drawing tax-free income from a reverse mortgage or home equity line of credit.
