I've been thinking about RRSP's lately, and I'm going to talk about a strategy that I came by that I'd like to share with you. This tax strategy is called the RRSP meltdown strategy.
What is the RRSP Meltdown Strategy?
This strategy is a way to withdraw from your RRSP's tax free. Typically, when you withdraw from your RRSP you pay tax on the withdrawal at your marginal rate. With this strategy, there will be no tax owing.
How does it work?
Pretty simple actually, setup an investment loan and make the interest payments from RRSP withdrawals (equivalent to the interest payment). Since the interest on the loan is tax deductible, the RRSP withdrawal taxation is canceled out. This results in zero tax owing on your RRSP withdrawal. The investment loan can be used to purchase dividend paying stocks to provide income during retirement which can be very tax efficient also.
Confused? Say that you paid out $10,000 in interest on an investment loan, but withdrew $10,000 from your RRSP the same year. The $10,000 from your RRSP is taxable at your marginal rate, but the $10,000 from the investment loan payments are tax deductible thus resulting in $0 tax owing.
Hopefully at this point, you are in a lower tax bracket, thus having a dividend based non-registered portfolio would be very tax efficient. Note that if you have a very large dividend based portfolio, it may affect your Old Age Security (OAS) payout. Dividends are grossed up (45%) which is counted as your income for OAS calculation purposes.
When should you do this?
I wouldn't suggest that someone go out and start withdrawing from their RRSP right away! This strategy may be helpful for those who are closing in on retirement and are strategizing their RRSP withdrawals. Remember, the earlier you withdraw from your RRSP, the more you reduce your tax deferred compound growth which can have a large effect on your portfolio value.
The RRSP Meltdown strategy is a great way to convert your RRSP into a non-registered income producing portfolio tax free! I will be looking into this further when my time comes. :)If you would like to read more articles like this, you can sign up for my free weekly money tips newsletter below (we will never spam you).