The RRSP season is over, but is the RRSP itself over? Rising criticisms of
the validity of the RRSP as an effective tax-savings vehicle mostly stem from
the fact that when funds are withdrawn they must be included as income at the
full marginal tax rates.
Contrast this with non-registered investing, which can have certain tax
advantages. Canadian dividends, for example, are taxed favourably outside an
RRSP or RRIF due to the dividend tax credit. Similarly, capital gains realized
in a non-registered plan are taxable at half your marginal tax rate.
For someone in the top marginal tax rate, RRSP or RRIF withdrawals are taxed
at an average rate of 46%. By comparison, Canadian dividends are taxed at a top
rate of about 32% and capital gains at a mere 23%.
However, if you earned those Canadian dividends and capital gains inside an
RRSP or RRIF, when you pull the funds out upon retirement, they are taxed as
ordinary income at your full, marginal tax rate.
The case against RRSPs is getting even stronger as the result of two proposed
tax initiatives that may come into force later this year.
The first is the Liberal Party's fall promise to enhance the dividend tax
credit. The Conservative minority government has stated that it will proceed
with this change. If the provincial governments agree to follow the feds, the
top average marginal tax rate for Canadian dividends will drop to just over 20%
Also threatening the appeal of RRSPs is the Conservative election promise to
eliminate the capital gains tax for individuals on the sale of assets when the
proceeds are reinvested within six months. If implemented, it would remove one
of the main tax advantages of registered investing -- the ability to rebalance
your investment portfolio without paying capital gains tax.
In light of all this, does the RRSP still make sense? While sheltering
capital gains from taxes is one of the primary advantages of RRSPs, it is
certainly not the only one. If you are like most Canadians, your entire
portfolio is likely not invested in equities. You probably own some fixed-income
investments, such as GICs or bonds. A registered plan is usually the best place
to hold such interest-producing assets because, otherwise, the income would be
taxed at full marginal tax rates.
Finally, perhaps the biggest advantage of an RRSP contribution is that you
get a tax deduction for the amount contributed.