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new thread for too much money in RRSP
March 20, 2016
6:01 pm
Loonie
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Norman1 said

...
However, if you are single or the surviving spouse, the entirety of your RSP/RIF (which may now include the RSPs of both spouses) will be taxed at your marginal tax rate on death. If you have even a relatively average middle class 200,000 to 500,00 in your plan at that time, the taxes will be huge. Any amount over approx. 200,000 will be taxed at about 50% depending on province, certainly much more than your tax rate when you made the contributions - particularly if you started young when your income was relatively low - and more than Heinzl or James were counting on. The more you have in the RSP/RIF, the more this will hurt. If you have 1.3 million, as I believe was suggested earlier, the tax on 1.1million of it will be 50% - more in New Brunswick! This is a particularly big problem if you should die at, let's say 71, as the principal will be at its highest.

That's the myth that Heinzl is trying to dispel: It is an illusion that the $1.3 million in the RRSP is yours. It's not. Large part of it is the government's.

If the RRSP contributions were $400,000 and the deductions were at the 40% marginal rate, the government refunds would be $160,000. So, the net cost to the RRSP contributor was $400,000 - $160,000 = $240,000. One ends up with control over $400,000, but not full ownership of the $400,000:

$240,000 Contributor's portion
$160,000 Government's portion
$400,000 Total RRSP

CRA becomes one's investment partner in the RRSP. Years later, let's say the RRSP grows to $1.3 million. Then, the situation becomes this:

$780,000 Contributor's portion
$520,000 Government's portion
$1,300,000 Total RRSP

When one withdraws the $1.3 million, one needs to send the government its portion. If one's tax bracket is still 40%, then one will send in exactly the government's portion of $520,000 and keeps $780,000. That works out to be exactly the same as if one had originally put $240,000 into a TFSA.

Again, we have the problem of a lack of detailed calculations.
The "government's portion" of 520,000 only applies if the tax on withdrawal in your situation happens to be 40% at the time of withdrawal. And the entire equation only works if you happen to be in a 40% marginal tax bracket time of investment.

Using data from http://www.ey.com/CA/en/Servic.....rsonal-Tax ,
the average tax rate on 1,300,000 for 2015 varied from 39% in Nunavut to 52.04% in New Brunswick. In the most populous provinces, Ontario and Quebec, it averages out to about 48%. Only two jurisdictions have a rate of 40% or less, namely Nunavut and Alberta. These rates would apply if the entire RSP were liquidated on death, at a minimum. If the deceased had other tax liabilities, then they would go up accordingly.

There is a lot more that could be said about the likely differences in the value of the deduction at time of investment at various times during one's working career, but I am not willing to spend the time sorting it all out.
And then there is the complicated situation of the person who lives and works in more than one province before retiring. Where will he retire, I wonder.

The case of 40% in and 40% out is an artificial construct. It fits an idealized person. Heinzl wanted to write an article that would attract attention by expanding on a kernel of truth. He succeeded. Raymond James wants to sell people on investing in RSPs because the money will more likely stay put than if kept outside. They too are succeeding, although not always without serious questions being raised. - http://www.wsj.com/articles/fi.....1403279773 There is usually a kernel of truth in most things, but it is not wise to take any of it at face value.

Real people have a variety of situations, and that is what they must pay attention to.
I would strongly urge anyone who has questions about whether they should invest in RSPs, and when, to have a competent independent person run a bunch of numbers for them, showing several possible scenarios for their lives.

March 22, 2016
6:11 am
Norman1
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That actual rate doesn't matter. The results are the same.

We can use a completely fictitious tax rate of 70%.

RRSP contributions of $400,000 and the deductions at the fictitious 70% marginal rate. The government refunds would be $280,000. So, the net cost to the RRSP contributor would be $400,000 - $280,000 = $120,000:

$120,000 30% Contributor's portion
$280,000 70% Government's portion
$400,000 100% Total RRSP

Again, years later, the RRSP grows to $1.3 million:

$390,000 30% Contributor's portion
$910,000 70% Government's portion
$1,300,000 100% Total RRSP

When one withdraws the $1.3 million, one needs to send the government 70% x $1.3 million = $910,000 which is the same as the government's portion of $910,000. Again, it works out to be exactly the same as if one had put $120,000, the after-tax cost of one's original contribution, into a TFSA.

Deduction rates on contributions and tax rates on withdrawals can fluctuate. But, if the average deduction rate on contributions and the average tax rate on withdrawals works out to be about the same, then one ends up paying little or no taxes on the gains in the RRSP from the after-tax amount of the contributions.

March 22, 2016
10:21 pm
Loonie
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Norman1 said

Deduction rates on contributions and tax rates on withdrawals can fluctuate. But, if the average deduction rate on contributions and the average tax rate on withdrawals works out to be about the same, then one ends up paying little or no taxes on the gains in the RRSP from the after-tax amount of the contributions.

The actual rate does matter.
Deduction rates on contributions and average tax rates on withdrawals are not going to be consistent for a given individual except by rare coincidence. To talk about an idealized 70% or 40% in and out does not correspond to people's experience, especially when it comes to estates, because these rates vary.

March 24, 2016
7:51 pm
Norman1
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Loonie said

Norman1 said

Deduction rates on contributions and tax rates on withdrawals can fluctuate. But, if the average deduction rate on contributions and the average tax rate on withdrawals works out to be about the same, then one ends up paying little or no taxes on the gains in the RRSP from the after-tax amount of the contributions.

The actual rate does matter.
Deduction rates on contributions and average tax rates on withdrawals are not going to be consistent for a given individual except by rare coincidence. To talk about an idealized 70% or 40% in and out does not correspond to people's experience, especially when it comes to estates, because these rates vary.

I see your point.

Yes, it won't be as good as a TFSA if the average tax rate on the RRSP withdrawals is more than the average deduction rate of the contributions.

Let's see what happens when contributions are deducted from 25% to 40%, averaging 32½%, and the withdrawals are taxed 40% on average.

$270,000 67½% Contributor's portion
$130,000 32½% Government's portion
$400,000 100% Total RRSP

Years later, the RRSP grows to $1.3 million:

$877,500 67½% Contributor's portion
$422,500 32½% Government's portion
$1,300,000 100% Total RRSP

When one withdraws the $1.3 million, one sent the government 40% x $1.3 million = $520,000, which is $97,500 more than the government's portion of $422,500.

The $97,500 extra could be seen as tax on the investment gain on the contributor's portion of the RRSP after one receives the original contributor's portion back tax free.

Gain on the original contributor's portion is $877,500 - $270,000 = $607,500.

The $97,500 tax on a gain of $607,500 is a tax of $97,500 / $607,500 = 0.1605 = 16.05%.

Not as good as tax free. But, not that bad either.

March 26, 2016
1:51 am
Loonie
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Glad you see my point, Norman.
I think we'd all rather keep the 97,500!

In any event, I think I will bow out of this discussion now. I'm not sure anyone else is listening anyway!

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