Author Topic: tax efficiencies of tax-deferred account (Canadian Version)  (Read 5450 times)

anisotropy

  • Pencil Stache
  • ****
  • Posts: 681
tax efficiencies of tax-deferred account (Canadian Version)
« on: September 12, 2014, 12:24:22 PM »
Looking for some Canadian inputs regarding this issue, as the tax situations are somewhat different in Canada.

I understand that generally a RRSP account helps with paying less taxes in retirement, assuming one's retirement ordinary income is less than income during employment. 

Last night gf and I had a RRSP discussion. While we have a RRSP account (for the match), it's no where near our contribution limit. The problem I have is that, as RRSP withdrawals count as salary/ordinary income, there's only so much we can take out (I think it's around $33,000 for two) before we start paying ~25% taxes on every dollar we take out.

I guess the question boils down to, does interest from GIC ladders and Bond Investments count as ordinary income? If we anticipate to receive $33,000/yr from interests in retirement using today's rates, does that mean we should forget about RRSP and just use taxable accounts ?

Thanks.

lavar

  • 5 O'Clock Shadow
  • *
  • Posts: 10
Re: tax efficiencies of tax-deferred account (Canadian Version)
« Reply #1 on: September 12, 2014, 12:50:42 PM »
Yes, interest income is taxed as regular income, vs capital gains and dividends which are treated favourably in unregistered accounts. The general sentiment is to have interest income in tax advantaged accounts (RRSPs and TFSAs).

I find there are a lot of powerful calculators at www.taxtips.ca that can help run a few simulations using income from various sources, (i.e., capital gains, interest, dividends). I'd just use the income tax calculator and play with some numbers to see what works out for you.

More information is ultimately needed to see what would likely be best under different scenarios, as your income sources in retirement can really influence where you are best placed to park your savings. If you would otherwise have no registered savings (pension plans etc...) then an RRSP is likely to form at least part of your retirement portfolio.


Spudd

  • Stubble
  • **
  • Posts: 215
Re: tax efficiencies of tax-deferred account (Canadian Version)
« Reply #2 on: September 12, 2014, 01:12:44 PM »
Last night gf and I had a RRSP discussion. While we have a RRSP account (for the match), it's no where near our contribution limit. The problem I have is that, as RRSP withdrawals count as salary/ordinary income, there's only so much we can take out (I think it's around $33,000 for two) before we start paying ~25% taxes on every dollar we take out.

The question is, what tax bracket are you in right now. If you're making (let's say) $50k per year right now, and you expect to take $33k per year from your RRSP in retirement, then in the end when you total things up, you'll pay less tax. If you invest that money in a taxable account, then you will need to pay income tax on it now at your full marginal tax rate, and then you'll need to pay tax every year on whatever dividends/capital gains/interest it accumulates. If you have it in the RRSP, the only tax will be the marginal tax upon withdrawal. So as long as your annual income in retirement is less than in working life, you come out ahead.

Also, yes, interest and bond income are both taxed exactly the same as salary.

anisotropy

  • Pencil Stache
  • ****
  • Posts: 681
Re: tax efficiencies of tax-deferred account (Canadian Version)
« Reply #3 on: September 12, 2014, 02:49:45 PM »
I see, so the way to look at RRSP is not about pay no tax from withdrawals, it's about to pay less taxes from withdrawals.

Pension is not likely to be a major source of ordinary income for us in retirement. Interests from GIC and Bonds (outside of RRSP) in retirement are likely to be over $30,000 so every dollar we withdraw from RRSP will incur around 25% tax.

But yes, it's still better than paying our current marginal tax on those amounts. Maybe we should fill up the RRSP contribution room with GIC and Bonds. Is that a good idea? Feels like we are wasting the "tax-free" growth potentials if we go with GIC and Bonds.

daverobev

  • Magnum Stache
  • ******
  • Posts: 3375
  • Location: France
Re: tax efficiencies of tax-deferred account (Canadian Version)
« Reply #4 on: September 12, 2014, 09:18:54 PM »
Not sure how old you are, but I don't think you want GICs AND bonds unless you're close to retirement.

Have you read any Canadian Couch Potato? There are good posts there on asset alloc, and the best place to put stuff for tax purposes.

Generally, the difference between a TFSA and an RRSP is when you pay tax. If you think you'll pay less tax in retirement, RRSP. More? Fill your TFSA first.

GICs are capital-protected, bonds (or rather, bond funds!) can fluctuate in value. If you are not retired, as part of your retirement savings you don't need GICs.

Canadian stocks are the best to hold unregistered as they are taxed very minimally.

RichMoose

  • Pencil Stache
  • ****
  • Posts: 966
  • Location: Alberta
  • RiskManagement
    • The Rich Moose | A Better Canadian Finance Blog
Re: tax efficiencies of tax-deferred account (Canadian Version)
« Reply #5 on: September 13, 2014, 06:41:31 AM »
Looking for some Canadian inputs regarding this issue, as the tax situations are somewhat different in Canada.

I understand that generally a RRSP account helps with paying less taxes in retirement, assuming one's retirement ordinary income is less than income during employment. 

Last night gf and I had a RRSP discussion. While we have a RRSP account (for the match), it's no where near our contribution limit. The problem I have is that, as RRSP withdrawals count as salary/ordinary income, there's only so much we can take out (I think it's around $33,000 for two) before we start paying ~25% taxes on every dollar we take out.

I guess the question boils down to, does interest from GIC ladders and Bond Investments count as ordinary income? If we anticipate to receive $33,000/yr from interests in retirement using today's rates, does that mean we should forget about RRSP and just use taxable accounts ?

Thanks.

The RRSP doesn't help you pay less taxes in retirement, it really just defers your tax bill from today until the time that you retire. All RRSP withdrawals, regardless of the form of income, are taxed as regular income. When people talk about lowering your tax bills by investing through RRSP, they are talking about claiming RRSP deduction when you're earning in the 30-40% tax brackets and then cashing RRSP's in retirement in the 15-25% tax brackets.

In Canada, you basically have three choices of saving:
1) RRSP
2) TFSA
3) Taxable accounts
Edit: 4) RDSP for people with qualified disability

Rule of thumb says that if you're "maxing out" all three accounts, you definitely do NOT want to hold bonds / GIC's in your taxable account. Your taxable account should really hold only Canadian dividend stocks. Some dividend ETF's are ok if they aren't to heavy in REIT and they have very low turnover. Then you also want to hold U.S. stocks in your RRSP because of tax agreements related to that account only. To see these benefits you need a USD RRSP account and you must purchase US securities directly (ie. they must be listed on the NYSE/NASDAX/ASE). It can not be a TSE listed ETF or a Canadian mutual fund that holds U.S. stocks (with a few that are exceptions because of their unique designs).

So armed with this knowledge, you then plan your investing together with your risk profile. If you're close to retirement you'll probably want bonds and GIC's in the mix. Where would you put these first? Theoretically your TFSA because your RRSP is filled with U.S. stocks and your taxable account with Canadian dividend stocks. If your TFSA is filled to the brim with bonds and GIC's and you need more, where do you put them next? Your RRSP. Sell some U.S. stocks and replace them with bonds. Because of the extremely good tax treatment of Canadian dividends and quite good tax treatment of Canadian capital gains, you should avoid holding anything other than Canadian stocks in your taxable account.

I hope this helps explain it a little better. If you have any more questions, just ask. :)

« Last Edit: September 13, 2014, 06:45:32 AM by TuxedoEagle »

RetiredAt63

  • Senior Mustachian
  • ********
  • Posts: 11345
  • Location: Eastern Ontario, Canada
Re: tax efficiencies of tax-deferred account (Canadian Version)
« Reply #6 on: September 13, 2014, 08:56:04 AM »
Tuxedo Eagle covered it pretty thoroughly.  Ideally the things that are taxed heavily should be protected (RRSP, TFSA) and once those have met the limits invest outside.  When you transfer your RRSP to a RRIF the income is taxed as income, it doesn't matter how it is generated.  Details - you don't have to transfer all of it, right now most of my RRSP has shifted, but the last two years of contributions are still in the RRSP.  This is because my adviser and I did the tax arithmetic and it made sense to start pulling money out earlier.  You do not have to wait until 71 to start using the RIFF, and starting earlier does make the tax situation gentler.  When you do the planning you need to also consider when you will start pulling your CPP and the effect of OAS.

Other thoughts - do an automatic payment to your RRSP/TFSA so it goes in regularly. Borrowing in February to top up your RRSP is not great.  We know lots of people do this, right?  We see all the bank RRSP loan ads then.  Also fill in the deductions form at work so that your taxes reflect this.  Well, if you will use the extra money wisely that that generates each paycheck.  Otherwise just give the government the interest-free loan and use the lump tax refund wisely.

Mega

  • Stubble
  • **
  • Posts: 176
  • Location: Burlington, Ontario
Re: tax efficiencies of tax-deferred account (Canadian Version)
« Reply #7 on: September 13, 2014, 09:08:44 AM »
Essentially, to max out the tax advantaged nature of each account:

US Securities in RRSP, due to tax agreements between USA & Canada. ***
Canadian REITs / Bonds / GIC in TFSAs, as these streams of income are treated as income in taxable accounts.
Canadian dividend paying stocks in taxable accounts.

However, if you already have enough money that you are maxing out everything, you are doing great.


*** Please note: There is a significant difference between holding a US S&P500 tracking ETF and a Canadian S&P500 tracking ETF. Why? The Canadian S&P500 tracking ETF has dividend taxes withheld, even though it is held in an RRSP. I havent taken the time to figure out the optimal way to hold an S&P500 tracking ETF in an RRSP. Extra points if you know the best way, ideally including a DRIP...

daverobev

  • Magnum Stache
  • ******
  • Posts: 3375
  • Location: France
Re: tax efficiencies of tax-deferred account (Canadian Version)
« Reply #8 on: September 13, 2014, 11:34:43 AM »
Essentially, to max out the tax advantaged nature of each account:

US Securities in RRSP, due to tax agreements between USA & Canada. ***
Canadian REITs / Bonds / GIC in TFSAs, as these streams of income are treated as income in taxable accounts.
Canadian dividend paying stocks in taxable accounts.

However, if you already have enough money that you are maxing out everything, you are doing great.


*** Please note: There is a significant difference between holding a US S&P500 tracking ETF and a Canadian S&P500 tracking ETF. Why? The Canadian S&P500 tracking ETF has dividend taxes withheld, even though it is held in an RRSP. I havent taken the time to figure out the optimal way to hold an S&P500 tracking ETF in an RRSP. Extra points if you know the best way, ideally including a DRIP...

Hold VTI, in $US, rather than VUN.TO, in CAD. Nothing withheld on the former in an RRSP.

Mega

  • Stubble
  • **
  • Posts: 176
  • Location: Burlington, Ontario
Re: tax efficiencies of tax-deferred account (Canadian Version)
« Reply #9 on: September 13, 2014, 03:54:01 PM »
Essentially, to max out the tax advantaged nature of each account:

US Securities in RRSP, due to tax agreements between USA & Canada. ***
Canadian REITs / Bonds / GIC in TFSAs, as these streams of income are treated as income in taxable accounts.
Canadian dividend paying stocks in taxable accounts.

However, if you already have enough money that you are maxing out everything, you are doing great.


*** Please note: There is a significant difference between holding a US S&P500 tracking ETF and a Canadian S&P500 tracking ETF. Why? The Canadian S&P500 tracking ETF has dividend taxes withheld, even though it is held in an RRSP. I havent taken the time to figure out the optimal way to hold an S&P500 tracking ETF in an RRSP. Extra points if you know the best way, ideally including a DRIP...

Hold VTI, in $US, rather than VUN.TO, in CAD. Nothing withheld on the former in an RRSP.

Have you been able to enrol VTI in a drip? Or do you just buy it whenever?

Canadian Nicole

  • 5 O'Clock Shadow
  • *
  • Posts: 21
Re: tax efficiencies of tax-deferred account (Canadian Version)
« Reply #10 on: September 14, 2014, 11:44:14 AM »
Question:   I've just started reading up on holding US stocks or ETFs in an RRSP, and I came across this info on US Estate taxes which may have to be paid.   Does anyone know about this or have a strategy to deal with it? http://www.taxtips.ca/personaltax/usestatetax.htm

Also, should the US holdings be in a US dollar account?    Thanks for any feedback on this!

RichMoose

  • Pencil Stache
  • ****
  • Posts: 966
  • Location: Alberta
  • RiskManagement
    • The Rich Moose | A Better Canadian Finance Blog
Re: tax efficiencies of tax-deferred account (Canadian Version)
« Reply #11 on: September 14, 2014, 03:40:54 PM »
My understanding is that U.S. estate tax doesn't apply to foreign residents who die with an estate of less than US $1.2m. There are also credits in place for when those assets are transferred to a spouse so estate isn't payable for several more million in assets. Then there's also other credits in place. Personally I'm not to worried about it at this point. It's really not much to be concerned about unless you have a very substantial estate. There is a calculator floating around somewhere for Canadians paying U.S. estate tax. A while back I remember doing an example for a $3m estate, $2m in U.S. stocks and my estate would owe Uncle Sam a grand total of $0. The whole system is designed to nail ultra wealthy people who hold substantial U.S. assets (like $10m+ estates).

U.S. holdings (directly held) should be in a USD account, yes. Only directly holding U.S. stocks / ETF's benefit from tax treaty exemptions on withholding taxes etc.

MorningCoffee

  • 5 O'Clock Shadow
  • *
  • Posts: 98
  • Location: Ottawa, Canada
Re: tax efficiencies of tax-deferred account (Canadian Version)
« Reply #12 on: September 14, 2014, 04:55:32 PM »
Moneysense magazine ran a RRSP feature which is pretty thorough if you check out the different tabs and articles.

http://www.moneysense.ca/invest/rrsp/what/what-is-an-rrsp

Generally, it's best to max out sheltered accounts before taxable, but there are exceptions.

anisotropy

  • Pencil Stache
  • ****
  • Posts: 681
Re: tax efficiencies of tax-deferred account (Canadian Version)
« Reply #13 on: September 15, 2014, 10:20:00 AM »
Thanks for all the replies. We thought that RRSP is not that useful for us but looks like we were wrong. Our retirement incomes are likely to be higher than our current income, but since most of the retirement incomes are not going to be ordinary, RRSP might still have a place in our plans.

Sure, the tax-savings are not that significant all things considered but I think it's still worth our time to look into this a bit more.

Thanks again.

RichMoose

  • Pencil Stache
  • ****
  • Posts: 966
  • Location: Alberta
  • RiskManagement
    • The Rich Moose | A Better Canadian Finance Blog
Re: tax efficiencies of tax-deferred account (Canadian Version)
« Reply #14 on: September 15, 2014, 11:17:17 AM »
anisotrophy, if you don't mind sharing, what will the majority of your retirement income consist of? There is a good chance that you may be better off not investing via an RRSP if you forecast a high retirement income.

anisotropy

  • Pencil Stache
  • ****
  • Posts: 681
Re: tax efficiencies of tax-deferred account (Canadian Version)
« Reply #15 on: September 15, 2014, 11:30:38 AM »
the majority of retirement income will be capital gains and eligible dividends (hence the not ordinary income comment).

we do plan on having a sizeable amount of reit, gic and bonds for asset allocation, we might use RRSP to hold some of it as some posters suggested, since they will be taxed as ordinary income anyway. I will bring this up when we meet our accountant and advisor next and see what they say.

RichMoose

  • Pencil Stache
  • ****
  • Posts: 966
  • Location: Alberta
  • RiskManagement
    • The Rich Moose | A Better Canadian Finance Blog
Re: tax efficiencies of tax-deferred account (Canadian Version)
« Reply #16 on: September 15, 2014, 12:43:58 PM »
It will be interesting to see what your advisors recommend. It probably will have a lot to do with their personal preferences / experiences regarding asset allocation.

Based on your comments, I'm guessing that you are holding a significant portfolio in Canadian dividend stocks in a taxable account. My guess is your advisors will recommend you max your TFSA and hold Bonds / GIC's in that. RRSP is interesting for you because if your dividend income is substantial, there is a very good chance you would be better off staying in Canadian dividend stocks and not investing heavily in bonds/GIC's, even within an RRSP. Basically resulting in bonds and GIC's making up less than 10% of your total portfolio. Canadian dividend payers tend to be quite stable, so a well diversified portfolio would mean steady income, increasing during good times and staying flat during market downturns all while paying hardly any tax.

The problem with having a lot of assets in your RRSP in addition to other income is that down the road the RRIF forced withdrawals can result in a substantial tax consequence. Maybe even pushing your total income up too high so that your dividends are taxed at much higher rates.

For fun, personalized tax scenarios try this calculator: http://www.taxtips.ca/calculators/canadian-tax/canadian-tax-calculator.htm

anisotropy

  • Pencil Stache
  • ****
  • Posts: 681
Re: tax efficiencies of tax-deferred account (Canadian Version)
« Reply #17 on: September 15, 2014, 03:30:46 PM »
Our TFSAs are maxed out with mostly index funds ( bond funds included) and some individual stocks. In hindsight it might have been a better idea to use the room for more gic/bond.

The forced withdrawals from RRIF is a core concern of ours, but if we start taking money out of the RRSP soon enough we should be able to avoid this unfortunate outcome. (Still have to pay 25% taxes, which sucks)

As for asset allocation, I am still leaning toward some bond/gic for the peace of mind (and that our approach is more nest egg than income streams), in the last recession someone I know lost quite a bit on his Canadian dividend portofolio (he suffered both captial loss and divi cut).

I think it scared me more than it scared him, sure he suffered a heart attack as a result of that but has since recovered both physically and financially and is off doing the same thing again, ie, a portofoilo full of preferred Canadian dividend stocks.

daverobev

  • Magnum Stache
  • ******
  • Posts: 3375
  • Location: France
Re: tax efficiencies of tax-deferred account (Canadian Version)
« Reply #18 on: September 15, 2014, 04:41:03 PM »
Have you been able to enrol VTI in a drip? Or do you just buy it whenever?

Depends what kind of DRIP you mean - there are two, synthetic and real. Real, no, not in a brokerage. Synthetic just means that, when a distribution (divi) is paid, they try and buy more shares rather than put cash into the account. The downside is that synthetic drips only deal in whole numbers - if the ETF is $100 a unit and your dividend amounts to $99.99, you get 0 new shares and all cash. If the divi is $159, you get one new unit and $59 cash.

How to enable synthetic DRIP depends on the brokerage, but in Questrade, I have everything auto-dripping.