Tax-free withdrawals from your RRSP
The Advocate, Wednesday February 8, 1995
In one of my articles on income, I wrote that you could buy an annuity or an RRIF with your RRSP. Both are fully taxable as regular income. With a little creative thinking, there is a way to take it out entirely tax-free on a regular systematic basis.
Let me explain. If you were to borrow $30,000 and invest it in the right mutual funds, the interest on the investment would be tax deductible. At 10 per cent interest, the loan would cost you $3,000 a year in interest. Next, remove $3,000 from your RRSP. This amount would be equal to your interest cost. Although taxable, it would be offset by your interest cost which is tax deductible. Now the money comes out tax-free. And remember, you also have a $30,000 investment working for you outside your RRSP.
In ten years at 10 per cent, it would be worth $77,812.27. At 15 per cent, it would be worth $121,366.73. In 20 years at 15 per cent you would have $490,996.12. All this would be funded entirely by the tax free proceeds from your RRSP.
After you pay off the loan at that point, you would net $490,996.12. You could then receive a monthly income from the mutual funds that would attract very little tax.
Your investment is still largely sheltered from tax (unrealized capital gain). In addition, it can be invested entirely in mutual funds investing outside Canada. Unlike your RRSP, you are not restricted to 20 per cent foreign content.
Recently, I have set up a similar program for one of my clients. Their mother has a considerable amount of money in her RRSP. We set up a RRIF for her in which her investments will continue to grow. When she dies, her RRIF will be commuted and the entire amount will be subject to tax on her final return. It will be taxed at her highest tax bracket. Over 50 per cent of the proceeds will have to be paid in tax. In order to lessen the impact of this excessive tax, we are using the above strategy to systematically deregister her RRIF tax free. This can be a very useful estate planning strategy, especially when a parent is uninsurable.
I like to refer to this technique as a washing machine to wash the tax out of your RRSP. Instead of washing out the dirt, it washes out the tax. Thanks to the recent axing of the $100,000 capital gain exemption, your dollars don't come out as clean from tax as they once did.
I have an example of how this tax strategy works. I would gladly send this example to anyone who requests one. Read next month's article, "How To Be Your Own Banker." In it, I'll explain other tax-saving strategies.
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