In or out? It depends on what you have
The issue of how RRSP funds should be invested has never been more
"Just get it in there" is the phrase often used by financial experts, meaning
that if you just make that RRSP contribution today, whether parking it in a
short-term vehicle such as an investment savings account or a money market fund,
you can decide how to properly invest those funds later on.
Sadly, investors often procrastinate and never book that second appointment
with their financial advisor, so their RRSP contribution languishes in low
interest paying vehicles for months, even years, before being strategically
re-allocated to more appropriate investments to grow for retirement.
While the investment decision should never be rushed, taking the time to
properly allocate your RRSP contribution from the start will pay off.
So, how should that money be invested?
The classic advice is that interest-bearing investments such as bonds should
always be held inside your RRSP. Equities, which generate 50% taxable capital
gains, should be held in non-registered accounts. Naturally, this advice applies
only to individuals who actually have a choice.
For Canadians still focused on paying off mortgages, there may be no other
funds left to invest other than those inside an RRSP. In that case, holding
equities inside an RRSP to maximize growth of retirement savings is an obvious
choice. Foreign dividend- paying equities are best held inside an RRSP while
Canadian dividend-paying stocks should generally be held outside such plans.
Enhancements to the Canadian dividend tax credit last year have significantly
lowered the effective tax rate on Canadian dividends. For example, the top
marginal tax rate on Canadian dividends in 2007 in British Columbia is 18.5%,
well below the province's 21.9% rate on capital gains. If Canadian dividends are
earned inside an RRSP, however, the dividend tax credit is lost and the income
when withdrawn is fully taxed at your marginal tax rate. For a B.C... investor
at the top rate, this means paying 43.7% tax on this income versus 18.5%.
Effectively, this amounts to double taxation, since a company that pays about
32% corporate tax on its income can only distribute the remaining 68% as a
dividend to its shareholders. The math gets worse: If that shareholder is a B.C.
resident holding the dividend-paying equity inside an RRSP, she will face a tax
of 43.7% on those dividends when withdrawn from her RRSP, resulting in a total
tax burden of nearly 62%.
A solution to this problem was recently proposed by tax professor Jack Mintz
of the Rotman School of Management. He recommends that RRSPs also be granted a
dividend tax credit to ensure that after-tax corporate profits from Canadian
corporations are not taxed twice.
Bottom line, you may wish to keep your Canadian dividendpaying equities
outside your RRSPs, which is now easier than ever thanks to the elimination of
the 30% foreign-content rule, permitting your RRSP to go global. - Jamie
Golombek, CA, CPA, CFP, CLU, TEP, is vice-president, taxation and estate
planning, at AIM Trimark Investments in Toronto.
GRAPHIC: Black & White
Photo: CanWest News Service; B.C. residents may want to keep Canadian
dividend-paying equities outside their RRSPs. ;