Tim s Tip 65: Recognize that it s possible to have too much in your RRSP in .NET framework

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I shared with my wife, Carolyn, last week that, at the pace we re going, we ll end up with far too much in our RRSPs in retirement I nearly pushed her over the edge into the realm of amazement when I told her this She wasn t so surprised that we ll have enough in retirement, but shocked that I suggested we d have too much in our RRSPs Like most Canadians, she believes that an RRSP is the cornerstone of any retirement savings program To suggest that we ll have too much in an RRSP seems crazy to her Don t get me wrong here I believe that having enough in your RRSP is a good thing Having more in your RRSP than you need to support yourself comfortably in retirement, however, doesn t make sense And why not Simple Every dollar that comes out of your RRSP is fully taxable With the capital gains inclusion rate at just 50 percent, you can create a pretty tax-smart portfolio outside your RRSP as well
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I have met a growing number of Canadians who have too much inside their RRSPs Some are taking advantage of a strategy called the RRSP freeze I believe there s a place for this strategy in some situations Let s consider Charlie s example
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expects to live to about age 90 and wants to plan for an income in retirement until that age a 25year retirement period Charlie wants a retirement income of $50,000 after taxes annually (in today s dollars) beginning at age 65 By the way, that $50,000 annually will equal $77,898 after taxes in the year Charlie reaches age 65, assuming a 3-percent inflation rate The bottom line is that Charlie will need $1,700,500 in his RRSP at age 65 to provide him with the income he needs in retirement (assuming a 10-percent annual return and 3-percent inflation annually) Here s the issue: Charlie already has $490,000 in his RRSP today Do the math That $490,000 will turn into about $2,050,000 by the time Charlie reaches age 65 even if he doesn t make another RRSP contribution (assuming a 10percent annual return) Do you follow Charlie will have about $205 million in his RRSP at age 65, but only needs about $17 million He ll have nearly $350,000 too much in his RRSP at age 65 even without further contributions
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harlie is a gentleman who is 50 and plans to retire at 65, just 15 years from now He
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How much is enough in your RRSP How do you know when you ve got too much in your plan First, you need to determine how much income you d like each year in retirement, in today s dollars Next, gure out how much money you need sitting in your RRSP on your retirement date to provide that income You ll have to make assumptions about your rate of return on investments, in ation, tax rates, and perhaps how long you re going to live Your best bet may be to visit a trusted nancial advisor who can crunch the numbers for you
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The problem with having so much in an RRSP is that every dollar in the plan is fully taxable when withdrawn Compare this to making withdrawals from an investment account outside of a registered plan where you ll face tax on any capital gains only And just one-half of capital gains are taxable
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What if there were a way for Charlie to remove some of the excess assets in his RRSP without any negative tax implications Would it make sense Arguably, it would particularly when he could then invest those assets outside of his RRSP in a manner that would result in more in his hands after taxes later Charlie has done that very thing Here s how: Charlie borrowed $125,000 at 8-percent interest and invested the money in high quality, conservative equity mutual funds Charlie makes interest-only payments on the loan, and the $10,000 of interest cost annually is deductible on his tax return Charlie then withdraws $10,000 from his RRSP annually to pay the interest costs The interest deduction offsets the taxable RRSP withdrawal so that he is effectively not taxed on the RRSP withdrawal What has Charlie really accomplished here He has managed to convert some of his registered money (in his RRSP) into non-registered money on a tax-free basis Think about it The $125,000 that Charlie borrowed is invested and growing It more than replaces the $10,000 withdrawn from the RRSP each year that was used to pay the interest costs on the loan In fact, Charlie will end up with more after-tax money in retirement through this strategy for two reasons: (1) By borrowing and investing $125,000, Charlie gets more money working for him sooner (compared to simply leaving the $10,000 annually in the RRSP and not borrowing any money), and (2) the withdrawals from the non-registered investments are taxed at much lower rates since capital gains are just 50-percent taxable, and only the growth on the $125,000 is taxed In Charlie s case, his after-tax retirement nest egg (dollars he can actually spend!) will be greater by $117,000 assuming a 10-percent investment return both inside and outside the RRSP over that 15-year period until he reaches age 65, and a marginal tax rate of 46 percent Some people refer to this strategy as the RRSP meltdown I prefer to call it an RRSP freeze To melt down an RRSP (that is, to actually reduce the amount of money in the RRSP over time) you ve got to borrow a heckuva lot of money (upwards of twice the value of your RRSP may be necessary) An RRSP freeze is easier to accomplish and this is what Charlie did A freeze simply caps the amount in the RRSP by making withdrawals annually to limit the growth in the plan
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