‘Un-Tax’ Retirement, Use RRSP Meltdown
This strategy will enable you to collapse your RRSP’s and convert them into a far more tax efficient non-registered type of savings vehicle. Typically, when you withdraw from your RRSP you are required to pay tax on the withdrawal at your marginal tax rate.
Implementing an RRSP meltdown strategy however, will significantly reduce income taxes to the point where they virtually become non-existent. (almost) The strategy is quite simple really, and works by first of all setting up a personal investment loan. The loan is then structured in such a way so as to have the interest payments, which are tax-deductible, offset the taxable income created by the RRSP withdrawal.
This will result in zero taxes owing on the money you withdraw from your RRSP. The investment loan could be used to purchase a segregated fund contract or perhaps a selection of guaranteed income funds which in and of themselves are also highly tax efficient.
Let’s Look at an Example:
Mr. Jones is 50 years old and is planning to retire at the age of 65. His RRSP currently holds $400,000 in GIC’s earning a rate of 3% annually. By the time he is ready for retirement his account balance will have grown to $623,187.00.
In order to maintain his current lifestyle Mr. Jones estimates that he will need to withdraw $50,000 a year from his RRSP after age 65. After factoring in his personal tax credits, he calculates that his average tax rate will be about 16%.
This will cost him about $8,000 in income tax on his RRSP withdrawal each year, leaving him with a net annual income of approximately $42,000.
He also comes to realize that by the time he reaches the age of 82 the funds in his RRSP will have been entirely depleted, and he will have paid Canada Revenue Agency $136,000 in income taxes on his RRSP withdrawals.
Mr. Jones makes the decision to borrow $300,000 for investment purposes, and purchases a segregated fund contract. It is an interest only loan at a rate of 4.0%, which creates for him an annual loan payment of $12,000. ( $300,000 x 4.0 % = $12,000 )
Because the interest charges are tax deductible, and Mr. Jones happens to be in a 40% income tax bracket, he will shave $4,800 off his annual income taxes. But that still leaves him $7,200 short on covering the cost of his interest charges. ( $12,000 – $4,800 = $7,200 )
His plan is to cover the remaining interest charges by drawing money out of his RRSP. If he draws out $9,000 per year he will incur a 20% withholding tax of $1,800 leaving him with $7,200, enough to cover the remaining interest charges on the loan. ( $9,000 x 20% = $7,200 )
In 15 years when he turns 65, the balance of his RRSP which is still earning 3%, despite having drawn out $9,000 a year, should have increased to a value of about $456,795.
In the Meantime…
The $300,000 segregated fund contract that Mr. Jones purchased has been compounding steadily at a rate of 6% per year. The value of the fund at age 65 would have grown to around $719,000, almost one and a half times the value of his remaining RRSP.
He decides to hold on to his investment loan a few more years and continues to cover the interest charges by taking extra money out of his RRSP. But instead of drawing out $50,000 a year from his RRSP as originally planned, for the next few years he withdraws $80,000.
The $12,000 tax deductible interest charge will bring his taxable income down to $68,000, leaving him an after tax income of about $54,000. This allows him to continue to covering the $12,000 interest payment still leaving him a with a net income of around $42,000.
The income tax on his $80,000 RRSP withdrawal each year will amount to about $14,000.
By his 71th birthday the funds in Mr. Jones RRSP will have been virtually depleted, while at the same time his segregated fund investment account will have more than tripled to around $1,019,869.
Mr. Jones now decides that it’s time to pay back the investment loan of $300,000, which will leave him with a remaining balance of about $719,869, and still earning an average of 6% per year. ($1,019,869 – $300,000 = $719,869)
Because his investment is no longer in a registered account the withdrawals are taxed as capital gains at 1/2 his marginal tax rate. A $44,000 withdrawal from his segregated fund account would only incur about a $2000 tax bill.
So instead of drawing out $50,000 from an RRSP to net $42,000, Mr. Jones can effectively draw out about $44,000 to net the same $42,000.
If his segregated fund contract continued to earn an average of 6% annually, the value of the investment at age 100 would still be worth almost as much as it was at age 71, somewhere around $660,000.
Not only has Mr. Jones extended his retirement lifestyle indefinitely, but if Mr. Jones were to pass away, the entire balance of his investment portfolio could be passed on to his beneficiaries tax free!
An RRSP Meltdown Strategy can be very beneficial to those who are closing in on retirement and need to begin strategizing their RRSP withdrawals. It is a great way to convert your existing RRSP into a more tax efficient non-registered income producing portfolio tax free. Contact an advisor today to learn more about the RRSP Meltdown Strategy and how it can work for you.
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