Myths about RRSPs
“Derek, I’ve heard it’s possible to get money out of your RRSP tax-free. Is that true?”
I hear that question quite often — and it’s certainly not true — but what is true is that there seems to be a lot of myths and misconceptions about registered retirement savings plans (RRSPs) that should be addressed.
To answer your question specifically, you can’t get money out of an RRSP tax-free, just like you can’t convince your employer to pay you tax-free. Those who claim that it is possible, use a leveraged asset strategy where the interest on the loan is used to offset the income from a client’s registered retirement income fund (RRIF) — a risky venture to say the least. Before considering this strategy, please ensure you have done your research and consider a second opinion.
Another common myth is that if you contribute to a spousal RRSP you can get twice the amount of annual deductions: one for the contribution in your account and another for the one you made in your spouse’s account. This is a common misconception.
The simplest way of remembering who can take the deduction is to remember that an individual has only one deduction limit based on him/her having earned income (or carryforwards) from a previous year. In the case where spouse A wants to contribute to spouse B’s RRSP, the contribution must be made based on spouse A’s RRSP limit.
For example, Jane has a limit (let’s say it’s $20,000) and can choose to contribute to her own RRSP or to John’s RRSP. Even if John also has a limit of $20,000, the most Jane can contribute is still $20,000, based on her own limits.
Jane cannot use John’s contribution room, although Jane could fund John’s contribution, but John will get the tax deduction. There can be benefits to contributing to a spousal RRSP, but it’s best to discuss that with your adviser and accountant.
Another common myth is that once investors contribute they have to claim the full amount as a deduction for that year. The truth is, many people lose sight of the fact that once the contribution is made the deduction does not have to be claimed and can be carried forward to a future tax year.
This can be a good strategy when an individual wants to take advantage of tax-deferred growth now, but knows they will be in a higher tax bracket in the future and will therefore get a better deduction. Consult your accountant for specifics on this.
Most investors assume that once they turn 71 they are no longer eligible to contribute to an RRSP. Nothing could be further from the truth.
No piece of legislation exists that states there are any age restrictions on making an RRSP contribution. Whether young or old, individuals can make a contribution as long as they have earned income in a previous year or at least have a carryforward amount from a previous year.
What this means, of course, is that someone who is over the age of 71 who has had to collapse their RRSP can still make a spousal contribution.
This, of course, assumes that the spouse still has an RRSP ( is 71 or younger) and the contributor is able to contribute because he/she either had earned income the previous year or still has carryforwards that were never used. Some investors believe that they may only contribute cash to their RRSP. The truth is that you don’t have to use cash. You can in fact also use stocks and bonds and make what is known as a “contribution-in-kind.”
The thing to remember is that the contribution of the asset is considered a disposition for tax purposes and as a result, tax would have to be paid on the capital gain. It is also vital to remember that if a capital loss should result from the transfer, this loss cannot be used for tax purposes.
Lastly, many investors believe that they can sell an investment to create a capital loss and then buy back the security in their RRSP. This is actually true! Contrary to popular belief, this is a recognized and acceptable tax planning strategy.
The idea here is that you would first sell the security that is held outside of your RRSP. Once the loss has been realized, you turn around and reacquire the security in your RRSP. This creates a capital loss and you maintain ownership of the position — a win-win.
Regardless of what strategy you’re considering, all of these concepts should be discussed with a qualified accountant. RRSPs and RRIFs have lots of myths and misconceptions and it’s important that you understand how best to use these powerful tools.
Derek Fuchs is a wealth adviser with ScotiaMcLeod in Red Deer, and a certified financial planner, financial management adviser and a fellow of the Canadian Securities Institute. He can be contacted at firstname.lastname@example.org.