Ice cream and RRSPs

Medicine Hat News - - BUSINESS - Steve Mel­drum

Once as a teenager, my older brother and I were at a gro­cery store when there was a sale on two-litre car­tons of ice cream. The store had my favourite kind, cook­ies and cream. My brother told me that if I could eat the en­tire two litres car­ton he would pay for it but if not then I would have to pay him back dou­ble the cost of the ice cream.

I was con­fi­dent I could eat it all so he bought it for me. I pro­ceeded to smile as I ate the ice cream. How­ever, as I got near the end I was not as en­thu­si­as­tic and it be­came dif­fi­cult to eat my favourite ice cream. It be­came un­pleas­ant to have so much ice cream and even made me a bit sick. Un­for­tu­nately, I could not com­plete the car­ton. There­fore, I lost out on our wager and I had to pay my brother more than the orig­i­nal cost of the ice cream.

This re­minds me of how RRSPs can be when we have too much of them. In­deed there can be too much of a good thing.

The idea of an RRSP is to make a con­tri­bu­tion to an in­vest­ment and the gov­ern­ment will pro­vide you with a tax de­duc­tion for that amount. The sav­ings are based on your marginal tax bracket. Thus more in­come you have the greater the ben­e­fit to pur­chas­ing an RRSP.

How­ever, you do even­tu­ally have to pay taxes when you re­deem the RRSP. The goal is to put money into an RRSP when you are in a high marginal tax rate and to re­deem it when you are in a lower marginal tax rate. If this is the case then the dif­fer­ence of marginal rates will in­crease the over­all re­turn of the in­vest­ment strat­egy. Un­for­tu­nately, just like my ice cream ex­pe­ri­ence, there can be a snag in RRSP plan­ning. When you pass away and don’t have a sur­viv­ing spouse, com­mon law part­ner or de­pen­dant child then all of your RRSPs be­come tax­able in the year of death. Yes, 100 per cent of your RRSPs will get added to your in­come and there­fore in­crease your marginal tax. I com­monly do stress test­ing of port­fo­lios and re­al­ize that the in­di­vid­ual can ac­tu­ally go back­wards by con­tin­u­ing to put money into a RRSP. That is be­cause they would be putting the money in at a lower tax rate than when they pass away and their es­tate is forced to pay a higher tax rate as the full RRSP is added to the in­come in the year of death.

What is a solution? One sim­ple strat­egy is to put life in­sur­ance in place to counter or pay the tax bill. In­deed the in­sur­ance can pro­tect your in­vest­ment port­fo­lio and not just your in­come. Although the taxes will still be paid the in­sur­ance can re­store the port­fo­lio back to its po­si­tion or even en­hance the port­fo­lio. The best part is that it is at a lower cost than do­ing noth­ing and sim­ply pay­ing the taxes. Although it is a great feel­ing to have a lot of RRSPs, I en­cour­age you to do a stress test of your es­tate plan and make sure that you don’t end up pay­ing more in taxes by hav­ing too many RRSPs.

Steve Mel­drum B.Mgt. CFP CLU is the founder of Swell Pri­vate Wealth Ltd. For over a decade he has spe­cial­ized in help­ing in­di­vid­u­als and busi­nesses ex­pand pro­tect and per­pet­u­ate their wealth. For fur­ther in­for­ma­tion or tai­lored ad­vice, con­tact him at 403487-0490, [email protected]­wealth.com or con­nect on so­cial me­dia.

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