Common wisdom to the contrary, contributing to an RRSP is not always the best strategy for everyone.

Lower-income individuals may find even limited RRSP savings will make them subject to the old age security clawback upon retirement, cancelling out any benefit that comes with accumulating retirement savings. Higher-income earners may prefer to save outside an RRSP so they can take full advantage of the favourable tax treatment of dividends and capital gains that are not available on investments within an RRSP.

John Bennett, executive vice president of products and operations at AGF Trust Co. in Toronto, suggests advisors explore various investment strategies with higher-income and high net-worth clients as alternatives to RRSPs. While taxpayers may claim a deduction for the full amount of an RRSP contribution, if it is withdrawn in its entirety at age 71, the amount in the plan will be fully taxed. With higher-income clients, the individual may well be in a higher tax bracket than when the contribution was made.

Alternatively, Bennett suggests higher-income clients borrow to invest in a portfolio of investments outside an RRSP. The interest on the loan is tax-deductible, because interest on money borrowed to earn an income may be deducted. The client could then benefit from the preferential tax treatment of capital gains — only 50% of the gain has to be included in income for tax purposes. In addition, the dividend tax credit is available on dividends from Canadian corporations.

Whether such a plan would benefit a client depends on age, income and overall wealth — and whether the client plans on using an RRSP for the Home Buyer’s Plan or making a spousal contribution to split income in retirement. Advisors need to look carefully at each situation, Bennett cautions, to calculate how a particular client might benefit from this approach.

“The rate of return assumptions make a huge difference in how these strategies play out,” he adds. “There is no black and white.”

TWO CONSIDERATIONS

Michael Dumond, partner and senior vice president at Money Concepts’ Diamond Tree Group of Companies in Barrie, Ont., says two issues need to be considered in RRSP planning: taxation of the client’s income during retirement and the client’s estate-planning needs. He cites a client who retired from a major corporation and transferred $1 million in accumulated pension benefits into a locked-in retirement account, thereby limiting his maximum withdrawal. When he dies, the funds can be unlocked and rolled into his spouse’s RRSP, but upon her death, the estate will pay tax on the funds at a rate of 45%.

By contrast, Dumond notes, taxes on non-registered investments apply only to the difference between the adjusted cost base (what was paid for the investments) and current market value — with only 50% of the gain subject to tax.

Estate planning for registered funds is a major tax issue, Dumond says. He suggests clients in a high tax bracket who are still working begin winding down their RRSPs at age 55 or so, turning them into RRIFs. That way, registered investments are eliminated by the time the client reaches retirement.

This would add to the client’s income, but additional tax deductions can be created to offset it. For example, funds could be raised through home equity loans: the money would be used to invest, making interest on the loan tax deductible. In this way, the client could create a pool of non-registered assets, while depleting the assets in the RRSP or RRIF.

The goal is for the RRSP/RRIF to be gone by the time the client reaches retirement. Then, he notes, with access to the preferential tax treatment of dividends and capital gains in the non-registered portfolio, the client will have more money to spend and less tax to pay. But, he warns, care is needed: if interest rates get too high, the portfolio may not be able to outstrip the cost of borrowing the money.

“Not everyone is keen on taking on debt against their home,” Dumond admits. “But their parents may have died with a house that was totally paid for and money that they never got to use,” he says. For those unwilling to use a home as collateral, he says, some financial institutions will accept investments as security for an investment loan with interest-only payments.

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Daryl Diamond, principal of Diamond Retirement Planning Ltd. in Winnipeg, says that for someone who expects to fall within the lowest federal tax bracket in retirement — less than $37,178 in 2007 — there is probably not much reason to disassemble an RRSP. However, he tries to encourage clients with considerable RRSP assets to reduce their RRSP holdings, pay the tax earlier than they otherwise would and defer taxes through non-registered assets.

That strategy is much more survivor-friendly for couples, Diamond says, and much more estate-friendly, as well. There is a number of ways to defer taxes on non-registered assets, he notes, depending on the product used. For example, non-registered term-certain or life annuities receive prescribed tax treatment.

As well, he says, systematic withdrawal plans offered by mutual funds’ T-series option are tax-effective; payments are structured so that the unitholder first receives a return of capital. The payments are also non-taxable until the sum of the payments exceeds the original adjusted cost base.

“Corporate class” mutual funds structured as corporations are also tax-efficient, with payments taxable in the form of capital gains, Diamond says. As well, variable annuities offered by some insurers, he adds, have a guaranteed minimum withdrawal benefit by which income is non-taxable until the sum of payments exceeds the adjusted cost base of the investment.

Many baby boomers lack non-registered assets, Diamond says. The RRSP disassembling strategies he proposes attempt to create non-registered funds for clients, and to find the most short- and long-term solutions that are most efficient for clients.

“RRSPs are a great tax deferral vehicle,” he says. “But advisors need to ask: ‘What’s the exit strategies for these assets?’”

What’s lacking most, he believes, is an assessment of how this will come out at the far end. IE