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Discussion Starter #1
Thanks for reading a Newbie's post! I would to garner some opinions on the wisdom of purchasing RRSPs in my position...

I am a 50% shareholder in a business. My partner & I draw salaries and dividends, which put us in a 40% tax bracket. We have owned this business for 11 years, and plan to keep it for about 10 more. In 10 years (or so) we plan to sell it, generating a fair whack (very technical term) of cash. At that point, I will be retiring.

I have resisted maxing my RRSP limit, as I have always felt that the tax burden I will see in the future on the capital gain from the business will be greater than it is now. This opinion goes against everything I've ever been told about retirement savings. That being said, I am finding the burden of 40% annoying, to say the least, currently.

My question is:

1)Do any of you have experience/advice regarding bucking the trend to buy RRSPs?

2) is the advice of "defer, defer, defer" always sound, or might it backfire?

or

3) Am I completely nuts by going against conventional wisdom?

I have posed my dilemma to my accountant (who didn't seem able to grasp what I was saying) and various financial planners (who were dismayed at the loss of a potentially good sale), but I would greatly appreciate some non-biased opinions. Is there some sort of formula I could use to crunch the numbers one way or the other?
 

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There are a bazillion (also very technical term) ways of reducing the tax hit when you sell the business, ranging from splitting the business into parts and selling the pieces, taking on an associate and selling over time to them, arranging the sale over time to a non-associate, and using holding corporations, section 85 rollovers, and income splitting reorganizations and estate freezes.

"Defer, defer, defer" is a strategy built on particular assumptions. In order to figure out whether this is the best strategy for you, you need to build (or have someone build) some models to make the assumptions explicit, and then you can test the impact of changing the assumptions and test (isolate) the assumptions themselves to run what-if scenarios. In general, the deferral strategy is typically based on nothing more than a TVM calculation: one dollar of tax payable in the future on a growing asset is preferable to one dollar of tax payable today.

"Conventional wisdom" applies to common situations. MOST people are not incorporated and do not have the tax-deferral mechanism of incorporation available to them.

Whether or not RRSPs work for you depends on a bunch (technical term again) of factors, including the total amount of income you are drawing from the business, your need for that income, the extent to which you can restructure your drawings to include more dividends (vs. salary), the amount you are sheltering in the corporation, your income needs over time (i.e., during retirement), your expectations for tax rates, your current tax rates, and a bunch of factors regarding your family situation (are there other people with whom you could split income) and your estate and legacy preferences.
 

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You're not bucking the trend. Just depending on how you operate your business and your future plans, you may or may not be better off using RRSP's.

I had a similiar conversation with my accountant a few years ago and he was quite clear that some business owners don't use RRSP's.
 

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If you are in Ontario and your current tax bracket is in the 40% range then it is either 43% or 46%. If it is the better one, you are giving up 43% savings on taxes now, so that in 10 years or so, "if" a big whack of cash comes in, you can save a lousy extra 3% in taxes, since the highest tax bracket currently is 46%. If you current bracket is 46%, you are not saving any money at all.

Max your RRSP now until you bring your income down to the next bracket (about $71,000 I think), and just always try to think of your future cash whack in "after tax" terms (77% of whatever you think you will get) and you probably will not miss the money you lose to taxes, as much.

If you are incorporated and do things right you may be eligible for a $750,000 capital gains exemption.
 

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Discussion Starter #6
Thanks for the replies and opinions.

MG - as you suggest, a model based on "what if" is exactly what I need! At this point, everything is merely academic for me without hard data. Your suggestions on reducing the tax hit are excellent and I will research them.

OE - I like your logic...3% IS measly! However, I'm not convinced that rates will stay as they are. Yes, the capital gains exemption will be helpful (and I've guarded mine jealously) but not entirely so.
 

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I'm in a similar position except I'm the sole owner of a corporation. I maximize my RRSP, at least for now, because I consider it a form of risk management. RRSPs, unlike earnings retained within a corporation, are creditor-proof. However, I may eventually opt to pay myself dividends only and not contribute to my RRSP once it reaches a certain size.
 

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If I understand correctly, your plan is to conserve RRSP room until the sale of your share of the business so that it can all be used at one time, to minimize the total tax bill.

One of the benefits you see to this plan is that you expect that tax rate charged on capital gains to increase from today's rate.


A couple of thing to consider as you evaluate this plan:


a) if the capital gains rate has increased - what will have happened to the
income tax rates by the time RRSP withdrawals occur?


b) what are the key features of an RRSP that will impact this plan?


c) what is the plan for the money what doesn't go into the RRSP?

If a significant enough portion is in say, stocks that pay dividends,
this may mean that when RRSP withdrawals occur, the top tax rate
may be unavoidable.


Cheers
 

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I'm in a similar position as well. I pay myself a salary from my corporation but I do not contribute to RRSPs at all. My salary is minimal such that it reduces taxes or at least allows me to not have to pay taxes at the highest bracket. When I was working full-time I contribute to taxes to have more than enough for the home buyer's plan withdrawal which I've already used.

There's always a chance that I may go back to a full-time job so I feel that I will contribute to RRSPs more when I have no control of my salary with the assumption that my salary would be in a higher tax bracket.

In addition, if I was to pay myself any lump sum amounts as a "bonus", I'd definitely contribute to RRSPs to reduce the taxation on that amount.
 
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