Ethos, the RRSP meltdown is to basically to take out a large investment loan and use RRSP withdrawals to service the investment loan interest. The tax on the rrsp withdrawal is negated by the investment loan tax write off.Can it be done effectively including minimizing the tax impact - are there ways to do it, if so what are they?
non-resident rule is 2-years, so for withdrawl at 25% you could leave December this year 2009 then as early as January 2011 (making it two calendar years that you were a non-resident at the end of each year) go ahead to withdraw the RRSP's at the lower tax rate.I tried to keep all my fixed income asset in my RRSP. Both for tax shelter and to prevent the RRSP from growing too large. A good reason to melt down RRSP is to leave the country and become a non-resident. Non-residents pay 25% taxes on OAS and CPP. However, the money would go much further in certain countries.
Preet, that was long but was very good, which cleared up a lot of unanswered questions for me.I've written before that there are some situations in which you would want to avoid saving too much to your RRSPs. In one way or another, the reason comes down to taxes.
The most common reasons cited for monitoring the value of your RRSPs:
1. Withdrawals are subject to your full marginal tax rate.
2. Registered withdrawals add to your earned income.
3. If your income is too high it may trigger clawback of your Old Age Security benefit.
4. You are required to make minimum annual withdrawals from age 72 onwards even if you don't need the money.
5. Non-Registered assets can be taxed much more preferentially (while living and at death).
Does the RRSP Leveraged Meltdown work? In theory, yes it does, but only if you expect to be comfortably in the highest tax bracket throughout retirement.
If your RRSP is the only source of retirement income (asides from CPP and OAS) then a meltdown would probably never make sense.
If you do fit the criteria of being comfortably in the top tax bracket, keep in mind that in the real world the risks involved are so great that I have to re-iterate that it is probably only suitable for the most speculative of investors (and even then it seems questionable).
1. Join the club! TFSA changes lots, though.1. The high marginal tax on RRSP withdrawals - not too happy about that one
2. The idea of the leveraged loan, which is really a wash & risky when you consider that you are giving away interest money for money taken out. These days loan rates are really low as is the low risk investments which you would need to take a very large loan to cover a minimal amount of RRSP withdrawal - say $5k
Is it possible or advantageous to meltdown using the flow through share (FTS) approach?
Example: Taking $50k out from the RRSP which after 20% witholding tax you'd put the $40k into FTS. This gives you 100% write off against the RRSP income, leaving you with a 20% tax credit
On maturity or expiration of the FTS the tax works out to approximately 20% (tax on 50% of the gain)
Understanding that there are no guarantees on FTS or SFTS return on the investment, is this a possible other approach?
Comments would be appreciated
I think you misunderstood my statement. "not allowing your RRSP to grow too large" does not equal to "not maximizing contribution". It has more to do with asset allocation than contribution amount.The issue of not allowing your RRSP to grow too large because it will be subject to major taxation after age 71 never seems to go away.
If you are going to analyze the problem, you have to include not just a tax rate, but the complete progressive taxation algorithm (over time). Remember, 1) tax rates are reduced in retirement (age credits), 2) the tax brackets are indexed, (which means that whereas tax on $50K is close to $10K, in 50 years time at 3% inflation, tax on $50K will be just $3.5K), and most importantly, 3) you have to look at tax, not as a raw number, but as its present value. The trade-off is an immediate tax refund offset against a far term tax hit... it is not a calculation for the faint of heart.
Generally speaking (for someone looking to live to a reasonable age) the most tax efficient plan is one in which the present value of all future tax pmts is minimized. Tax can't be looked at as a single average or marginal rate or factor... it has to be integrated into a financial plan to the same level of detail you use when you do your T1. I have examined many financial plans, and in very few situations (unless you do creative gaming with leverage), have I been able to make a case for not sheltering and/or not maximizing your RRSP.
There is one exception, however....since last year, a case can now be made to preferentially contribute to your TFSA before maxing your RRSP. The advantage is not extreme, however.
Again, I was talking about asset allocation, not contribution.Again... unless you actually examine the numbers, even the deferred capital gains (equity) strategy doesn't necessarily work either.
Take a 40 yrold earning 65K, with 200K in his rrsp and retiring at 65.
Let's say that at age 70 he needs a lump sum 180K (after tax) in excess of his normal lifestyle. If he pulls it out of his RRSP, he suffers a big tax hit, driving him into the next mtr.
Now, what would happen if he anticipated that special need at 70, ahead of time (now, say). So, instead of continuing to invest in his RRSP, he starts to save (4000 a year in a deferred capital gains entity which grows tax free such that at the point of his special need, he can extract the lump sum without any extra tax hit (due to the 50% capgains tax reduction)
Now... when you look at the total tax he pays over the life of his entire plan, the 'equity' strategy invokes 1.13M total tax and the rrsp strategy 1.24M. Looks like the equity strategy wins, right? Well, no. When you look at the present value of all those tax pmts, the rrsp strategy invokes 292K tax (pv-ed) and the equity draws 296K.
These aren't drastic differences, but it shows that even when comparing tax efficient savings (capgains or dividends) maxing the RRSP still has an advantage.