RRSPs – A rare tax break

The TaxLetter, MPL Communications Inc.
133 Richmond St.W., Toronto, ON, M5H 3M8. 1-800-804-8846

Some investment advisors think that you should never again contribute to an RRSP. In fact, some go further and suggest that you consider a meltdown of your RRSP. These advisors correctly note that RRSPs expose you to more income taxes than capital gains do. But we feel they fail to fully appreciate other advantages that RRSPs give you. Our advice: keep contributing to your RRSP. Also maximize your TFSA (or Tax-Free Savings Account).

These days, of course, you pay tax on only half of any capital gains you make. By contrast, you pay tax on every dollar you withdraw from a RRSP or a RRIF. So some advisors will tell you to stop contributing to an RRSP. They think you should instead buy high-quality stocks or stock mutual funds. These investments will produce capital gains by the time you retire and cut down on your tax bills.

We see several flaws with this viewpoint. First, you get a tax break within months of contributing to your RRSP. Those who buy stocks or stock mutual funds, by contrast, get no tax break. Remember, too, that RRSPs give you these tax breaks when they count the most—in your working years when you normally face a high marginal tax rate.

Second, RRSPs let your money compound tax free. Money held outside tax-deferred plans, by contrast, can produce taxable capital gains in your high-tax working years. Mergers and acquisitions might force you take these capital gains. Or you might take capital gains if you expect the performances of some of your stocks or stock mutual funds to deteriorate.

Besides, you’ll certainly face taxes on the dividends or distributions these stocks or stock mutual funds pay out. Sure, you might buy only stocks that pay no dividends.

Third, you’ll likely only withdraw from your RRSP or RRIF when you’re no longer earning income. At that point, of course, you’re likely to face a lower marginal tax rate. In other words, the taxes on RRSP and RRIF withdrawals may be less severe than some advisors would have you believe.

We, too, think capital gains are fine way to earn income. Indeed, we advise you to invest extra cash you don’t need into high-quality stocks or stock mutual funds, including index exchange-traded funds.

At the same time, however, continue to maximize your RRSP contributions. They’re one of the few tax breaks Canadians have left and their advantages are just too good to pass up.


The TaxLetter, MPL Communications Inc.
133 Richmond St.W., Toronto, ON, M5H 3M8. 1-800-804-8846

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