With the 2005 RRSP-contribution deadline looming on March 1, here are three
"advanced" RRSP ideas to consider.
Putting your mortgage in your RRSP You can put your mortgage into a
self-directed RRSP as long as it's administered by an approved lender and the
mortgage interest rate and other terms and conditions reflect normal commercial
practices.
In addition, your mortgage must be insured either by the Canada Mortgage and
Housing Corp. (CMHC) or by a private insurer of mortgages such as Genworth
Financial Canada (formerly GE Mortgage Insurance Canada). The reason for the
insurance is to make sure that if you default on your mortgage, your retirement
savings will not also be at risk.
The primary advantage of putting your mortgage in your RRSP is that instead
of paying a lender such as a bank each month, you are paying yourself (through
your RRSP). In addition, the mortgage interest rate you pay yourself can
generally be higher than the rate you could earn on other low-risk, fixed-income
investments such as GICs.
The biggest drawback is cost. While there are the typical one-time mortgage
expenses, the mortgage insurance premium can range from 0.5% to 2.75% of the
amount of the mortgage (depending on its loan-to-value ratio). The premium is
calculated on the total amount of the mortgage, regardless of the amount held
within your RRSP.
There may also be annual fees for maintaining the self-directed RRSP, as well
as the usual mortgage administration fees many financial institutions charge.
Taking into account the costs, be sure to compare the rate of return on the
mortgage with the rate of return on alternative fixed-income investments before
making your decision.
Investing in shares of a small business You can also use your RRSP to invest
in shares of a qualifying Canadian small-business corporation (SBC). The rules
state, however, that you can't own personally, or with a related person, more
than 10% of any class of shares of the corporation. If you own more than 10% and
are at "arm's length" from the company, you're OK as long as the total cost of
all of the shares you own is under $25,000.
There are a couple of potential drawbacks. First of all, there is generally a
lack of liquidity in SBC shares. Second, the capital gains on the sale of the
SBC shares outside an RRSP may be eligible for the lifetime $500,000
capital-gains exemption on qualifying SBC shares. This would not be available if
held in an RRSP.
Employee stock options There are no immediate tax consequences when employee
stock options are transferred to your RRSP. And you'll get a contribution
receipt for the fair market value of the options transferred. When the RRSP
exercises the options, you must then include in your income an employment
benefit equal to the difference between the fair market value of the shares on
the day the options are exercised and the exercise price.
Assuming the options qualify, and most do, you can claim a 50% deduction on
your tax return. The net effect is that the employment benefit is taxed at the
same rate as a capital gain.
The big tax problem with this strategy occurs when the shares acquired upon
option inside the RRSP are eventually sold and the proceeds paid out to you. The
entire proceeds will be taxable to you as an RRSP (or RRIF) withdrawal, despite
the fact that the stock-option employment benefit has been previously taxed in
your hands. This clearly results in double taxation.
As a result, it is much better to exercise your stock options before
contributing them "in kind" to your RRSP. By doing so, you can get an RRSP
receipt for the fair market value of the shares contributed and there will be no
double taxation when the shares are ultimately sold by the RRSP and the proceeds
paid out in retirement.