RRSP Meltdown Strategy

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.  

Conclusions:

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. :)

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Posted in
Frugal Trader

FT

FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.
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Ansix12
4 years ago

This comment trail has not been active for a long time. But I will post a question anyway. This approach is rather interesting. I have a holding company that was created for creditor protection purposes. My question is this, instead of borrowing the money to invest from the bank. Can I borrow from the holdco and pay interest to it instead? Or is the attribution rules make this not possible?

Thanks

Ansix12

Thomas Venner
10 years ago

Sam, which finacial services company do you work for? I would think you would have been given some information about RRSP basics ;)
To answer your question, your 2010 contribution room is based on your 2009 income, therefore you have no contribution room. Did you file taxes for 2009? If so your notice of assesment (NOA) will tell you haow much contribution room she has. Did your wife have any 2009 income? If so her NOA will give your her 2010 contribution limit.
Based on your income for 2010, you will have a contribution limit of 18% of “earned income” up to a max of just over $22k. Sposal or non-spousal the “tax savings” are the same. When you retire the spousal plan may have certain advantages depending on your retirement and pension situation.

sam
10 years ago

I have a question for you. I am a new immigrant to Canada (immigrated in Sep 2009). My total income for 2009 was zero. In May, 2010 I got a job in a financial services company. My income for 2010 is $55,000 approx. My wife is a homemaker. We have a 2 year old. I want to open an RRSP account. My questions are: should I open an account for myself or my wife so that I can get the most tax savings? What is the maximum that I contribute for the year?
Thank you for your help,
Sam

rick_k
11 years ago

frugal trader
good strategy except for in quebec where the interest expense is adjusted since there is no interest earned

Bhangi
12 years ago

Not sure if any of you have considered a slight variation of this strategy. Instead of starting this strategy closer towards retirement, start it ASAP.

1) Obtain an interest only investment loan and make the interest payments through RRSP withdrawls.

2) Invest in Canadian Dividend paying stocks and use the dividends to decrease the principal.

3) Every year, add additional funds to the RRSP account for obvious tax advantages. And since more funds are now available, have the loan amount increased accordingly and invest in additional Canadian Dividend paying stocks.

4) Due to dividend growth, hopefully the income stream from dividends should be enough to support an early retirement 15-20 years down the road. At this point, stop contributing any further to the RRSP and exhaust the remaining RRSP funds towards the loan interest.

5) In a few years when the RRSP has been depleted, the income should have achieved such levels where a retirement and loan interest should be covered. Any remaining income can be used to pay off additional principal.

6) Keep enjoying an increasing income and it is up to your discretion as to how much want to contribute towards the principal to pay off the loan faster or keep the loan and make interest only payments, similar to the Smith Manouver.

I have not run through the numbers but just wanted to throw this idea out there and get your input.

cannon_fodder
12 years ago

DK,

That’s right and in fact even the withholding tax is monitored for cumulative withdrawals. I had initially thought you could take out $5,000 amounts as often as you want and only have 10% withholding tax each time but it doesn’t work that way. That first dollar after $5,000 is taxed at 20%.

DK
12 years ago

Matt,

The withholding tax is not “in addition” to income tax, it’s only an “advance” — so the CRA gets their money sooner (or more accurately: to make sure they get it at all and you don’t simply run off with the money). When you file your return the CRA calculates how much tax you owe versus how much was withheld and then credit or debit you accordingly.

Matt
12 years ago

Frugal Trader:

Your technique is flawed. There is something called witholding tax, which you pay in addition to income taxes when you withdrawal money from your RRSP. The taxes do not cancel out.

Best of Luck,

Matt Noel

How Registered Retirement Income Funds (RRIF) Work | Million Dollar Journey
12 years ago

[…] Meltdown: This is very similar to the RRSP meltdown that I’ve written about before, except now, the RRIF withdrawals are used to service the […]

Acorn
13 years ago

How about this scheme… Use RRSP to support an investment loan. Use this loan to invest in a “T” fund (as it was suggested – see comment #5). Receive distributions that are 100% ROC (tax free) . Use these monthly distributions, which generally will be LARGER than monthly RRSP withdrawal, to make a NEW RRSP contribution. So, instead of RRSP meltdown we have RRSP build up + a nice RRSP tax refund, which can be invested back in a “T” fund. Zero money from your pocket for this “Anti-meltdown maneuver” to grow your RRSP and support non-registered investments. Will it work?