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Discussion Starter #1
There's a few things I need cleared up about RRSPs. I'm about to start contributing, but I want to make sure it's the right thing for me. RRIFs, you have to convert all of you RRSP accounts by 71, but can as early as 55. Do you have to convert all your RRSP accounts over to a RRIF if I want to start drawing on some of my money at 55? How does the mandatory withdrawal percentage work. Is it just based on the total in the account at the beginning of each year? Do you have complete control over how the money is liquidated out of the account? (forced to sell assets) And what happens if you don't take out enough? Is the government going to go into your RRSP and start selling your investments to cash out? Is there any disadvantage of just withdrawing from your RRSP instead of converting to the RRIF for people 55-71? (other than the withholding tax)

I'm a bit confused about the marginal rate. Say I'm $5000 into the 36% bracket. If I make a $10000 contribution will I get back 36% of 10000 or 36% of 5000 and 32% of 5000?
 

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If I make a $10000 contribution will I get back 36% of 10000 or 36% of 5000 and 32% of 5000?
It depends on your salary. The refund is essentially whatever tax on your full salary would be minus tax on (your salary less your contribution)
 

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Discussion Starter #3
Right. So if I were going to "optimize" my return I may be best to only contribute enough to get me out of the tax bracket I'm in.
 

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Forget about what tax bracket you are in.... an optimum (long term) solution is to generally maximize your rrsp contribution.
 

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Forget about what tax bracket you are in.... an optimum (long term) solution is to generally maximize your rrsp contribution.
You can maximize your contributions yes, but if you want you can delay claiming them on your tax return until the next year if you think your income will be higher and/or won't be contributing as much.
 

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Do you have to convert all your RRSP accounts over to a RRIF if I want to start drawing on some of my money at 55?
NO ... prior to age 71, you can convert just a portion of your RRSP to RRIF, while leaving the balance unconverted, if you wish.

How does the mandatory withdrawal percentage work. Is it just based on the total in the account at the beginning of each year?
YES ... or more precisely, it is based on the closing balance in the account at the end of the prior year.

Do you have complete control over how the money is liquidated out of the account? (forced to sell assets) And what happens if you don't take out enough? Is the government going to go into your RRSP and start selling your investments to cash out?
The RRIF rules do not cause money to be “liquidated” out of the account, nor do they force the sale of assets ... the rules merely require withdrawal ... YES you have complete control over how that money is withdrawn ... or rather, you have the opportunity for complete control, if you choose to exercise it. If you choose not to, or are unable to, exercise that control then of course there are mechanisms in place to ensure that the withdrawal takes place, but NO, the gov’t will not go into your RRIF and start selling your investments. Your trustee (your broker or financial institution) will ask you for instructions, and if you fail to provide them, they will fall back to some default procedure for implementing the necessary withdrawal. Different trustees may have different default procedures.

Is there any disadvantage of just withdrawing from your RRSP instead of converting to the RRIF for people 55-71? (other than the withholding tax)
Well, the withholding tax can be a big disadvantage, particularly since the rate of withholding can exceed the actual tax burden on withdrawals by quite a wide margin, but yes there are other disadvantages as well ... RRSP withdrawals are not eligible for the Pension Amount tax credit, or for pension splitting, while RRIF withdrawals are, starting at age 65.

So if I were going to "optimize" my return I may be best to only contribute enough to get me out of the tax bracket I'm in.
Maybe ... or maybe not ... optimizing of RRSP contributions is something that occurs over the course of one’s lifetime ... it isn’t an annual event ... therefore, sometimes the optimal approach will be as you suggest, and other times it won’t be ... in some cases, the optimal approach would be to contribute and deduct a larger amount, regardless of whether your deduction crosses bracket boundaries. Note that there can be various other non-income-tax items that could be impacted by your RRSP contribution, and are not reflected in your marginal rate.

Delaying taking the deduction until you are earning in a higher bracket can sometimes work to your benefit, but it can also sometimes lead into a trap whereby you end up reducing your aggregate lifetime tax break instead of increasing it.

Focus on the big picture.
 

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Discussion Starter #7
Thank you very much everyone, that was very informative Cardhu. I'm just trying to get a clearer picture of the rules and tax treatments of various account types like RRSPs, TFSAs, holding companies, and trusts.
I understand that in a lot of cases it may be best to just max out your RRSP every year. So it seems like main risks of the RRSP route are income tax rate risk - what if the income tax rate in 50 years is 50%? Unlikely but it could happen. And market risk - what if I'm 85 and required to withdraw 10% and the market tanks? I'm also starting into a career as an engineer in which I have a (hopefully small) chance of getting sued, and perhaps a holding company or family trust would help protect a certain portion of my assets from that risk.

The more I think about it the more complicated it seems to get... the more I learn about money management the more I don't know. You either have to go all in or pay someone big money to do it for you and hopefully not screw it up!
 

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peterk said:
So it seems like main risks of the RRSP route are income tax rate risk - what if the income tax rate in 50 years is 50%?
Well, you have to put this in perspective … the nature of RRSPs is such that if the tax rate is the same at contribution and withdrawal, then the returns earned inside the RRSP are effectively taxed at ZERO percent … the same end result as a TFSA … but the reality is the vast majority of the population faces a lower tax rate on RRSP withdrawals than on contributions, if they are using the RRSP as it was intended to be used, and therefore, they enjoy a NEGATIVE tax rate on those investment returns earned inside the RRSP.

Tax rates may very well rise in the future ... but you have to ask yourself, how high are they likely to go? ... and how soon? ... the RRSP can withstand some degree of tax rate increases, without losing its inherent growth advantage ... it can overcome a small rise in rates over the short term and the longer the holding time, the greater the tax hike it can overcome ... There are uncertainties, of course, there always are ... but if the magnitude of the change required to derail any particular approach is so great that it is difficult to imagine it happening in our lifetime, then the probabilities are pretty solidly in favour of that approach.

And market risk - what if I'm 85 and required to withdraw 10% and the market tanks?
Market risk is not unique to RRSPs ... all of your equity investments face market risk, regardless of whether they are held in a registered account or not ... the RRIF withdrawal schedule simply represents a tax-efficient mechanism to deregister the assets ... there is no requirement that you spend the money, only that you move it outside of the shelter of the RRSP ... and if you move it outside during a period when valuations are low, the withdrawal will be even more tax efficient than it otherwise would have been.
 
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Hello cardu ... you say … "the nature of RRSPs is such that if the tax rate is the same at contribution and withdrawal, then the returns earned inside the RRSP are effectively taxed at ZERO percent" … if I deposit say a total of $20K and over 10 years get that up to say $100K, the return of $80K (as well as the $20K) is taxed on withdrawal.
 

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This might explain what Cardhu means by zero percent.

Our guy is 35, he earns $50K per year, retires at 65. He starts out with an RRSP of $50K.

Two scenarios.... in the first, he continues to invest in his RRSP, in the second, he invests in a tax-free vehicle.

The RRSP strategy returns him a constant after tax (constant) income of $33,040.

In the second scenario, he avoids further contributions to his RRSP, and all savings are directed to a TFSA. This time his constant ATI (dying broke at 95) returns him a $32,843 inflation adjusted lifestyle.

Therefore you could say that the RRSP was effectively (just better than) tax-free.

RRSP scenario
Taxfree scenario
 

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steves said:
This might explain what Cardhu means by zero percent.
Not really … tax rates are not the same at contribution and withdrawal in your model.

rikk said:
if I deposit say a total of $20K and over 10 years get that up to say $100K, the return of $80K (as well as the $20K) is taxed on withdrawal.
Yes, of course RRSP withdrawals are taxed … and RRSP contributions are deductible … and if the applicable tax rate at withdrawal is the same as the tax rate on contribution, then the result is an effective tax rate of ZERO on the returns … the RRSP produces exactly the same after-tax result, that would have been achieved by investing the money instead in a non-reg account, if that non-reg account had been taxed at ZERO percent.

Here's a simple example ... lets say your tax rate is 50% throughout your life … so when you collapse your $100K RRSP, you end up with $50k after tax … and if you invested that same $10K outside of RRSP over those same 10 years, it’d grow to $50K, of which $40k is growth … if that growth were taxed at 0% percent then you’d end up with $50k in your pocket, after tax … just like the RRSP … unfortunately, non-reg investments aren’t taxed at 0%.
 

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Not really … tax rates are not the same at contribution and withdrawal in your model.
I find it very hard to manufacture a plan in which the tax rate in retirement is the same as pre-retirement. Certainly, not for a working/saving, retiring/withdrawing, dying broke sequence.
 

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The model makes the assumption that the current tax rules (T1) will continue into the future. Everything else.... rates, inflation are what they are. This is not a theoretical model, it is the actual mathematical description of the financial and taxation system we live in.

My example was to compare investing for that individual in RRSPs in one case and investing in a taxfree entity in the other case. The fact that the RRSP case returned a higher after tax income than the taxfree case says to me that the RRSP is a (close to) zero tax investment.

As I said.... it is hugely difficult to find a situation where the tax rate after retirement is the same as before retirement, unless you make assumptions about a major arbitrary tax armageddon down the road.
 

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Hello cardu ... you say … "the nature of RRSPs is such that if the tax rate is the same at contribution and withdrawal, then the returns earned inside the RRSP are effectively taxed at ZERO percent" … if I deposit say a total of $20K and over 10 years get that up to say $100K, the return of $80K (as well as the $20K) is taxed on withdrawal.
Assume your average contribution tax rate and the average withdrawal tax rate is 50%.

Inside a RRSP:
Deposit: $20K
Withdrawal $100K after 10 years.
After-tax: $50K

Outside a RRSP:
Deposit: $10K (because RRSP contributions are pre-tax)
Withdraw: $50K after 10 years. (your investments grow the same 5x in 10 years).
At a 50% capital gains inclusion rate, you'll have $40K after taxes

So, you can see that in theory a RRSP is better. In fact, the taxable account almost certainly lags even more for most tax brackets because you'll regularly pay taxes on dividends and portfolio turnover. Whereas all your investment growth is sheltered within a RRSP.

In the top tax brackets, you are almost certainly better off contributing to a RSP.
 

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It is easy to say something like 'average tax rate in retirement of 50%'.... it is much more difficult showing how such a tax rate could be encountered in the course of a normal working-retired lifetime profile. Unless your name was Donald Trump or Bill Gates.
 

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It is easy to say something like 'average tax rate in retirement of 50%'.... it is much more difficult showing how such a tax rate could be encountered in the course of a normal working-retired lifetime profile. Unless your name was Donald Trump or Bill Gates.
Is it really that uncommon to not have the same income tax rate in retirement as prior to?
Consider most of our poor, hard-working, pensioned public sector workers, who receive 90% of their highest drawn salary (or average of 5 best years) after retirement as pension.
I believe teachers and health care workers get similar pension deals.
So that 90% plus the interest/returns from their non pension savings might easily get them to 100% of their pre-retirement income or even above.
 

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Is it really that uncommon to not have the same income tax rate in retirement as prior to?
Consider most of our poor, hard-working, pensioned public sector workers, who receive 90% of their highest drawn salary (or average of 5 best years) after retirement as pension.
I believe teachers and health care workers get similar pension deals.
So that 90% plus the interest/returns from their non pension savings might easily get them to 100% of their pre-retirement income or even above.
I'd sure like to know which plans pay out 90% of one's salary. Mine pays a maximum of 70% and that's after 40 years of service. Not many people make it to this amount or even close to it.
 

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Is it really that uncommon to not have the same income tax rate in retirement as prior to?
Consider most of our poor, hard-working, pensioned public sector workers, who receive 90% of their highest drawn salary (or average of 5 best years) after retirement as pension.
I believe teachers and health care workers get similar pension deals.
So that 90% plus the interest/returns from their non pension savings might easily get them to 100% of their pre-retirement income or even above.
There's no such thing as a pension plan in Canada that offers a 90% replacement ratio after retirement. The most that any defined-benefit plan offers is 2% for each year worked, up to a maximum of 35 years - that totals 70%.

The assumption, of course, is that the nurse/teacher/public servant will stay employed with the same employer for 35 years - this is hardly the norm nowadays, even amongst public sector workers.

Also, bear in mind that pensions aren't free. The employees and employer pay for them via deductions off of each and every paycheque - around 5.5% for earnings below the YMPE (because CPP also covers that amount) and 8.4% for earnings above the YMPE.
 
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