If you have losing stocks in your RRSP, now is the time to set them free.

Swapping out struggling stocks can be a tax win

If you’ve been an investor for any significant period of time, odds are you can probably find a handful of losing stock picks tucked inside your Registered Retirement Savings Plan. Once they drop below what they cost you, the tendency is to hang on to the losing positions in the forlorn hope that one day they will “come back” — at least to what you paid for them.

However, tragic as the paper losses may seem, there may be a silver lining here. By “liberating your losers” and transferring them “inkind” ( that is, not selling them) to your non-registered or taxable investment account you can accomplish several things.

As an example, imagine you had $15,000 of book value or adjusted cost base that has fallen to $ 5,000 in current market value. Yes, your RRSP is “down” $ 10,000, which is regrettable.

However, by liberating your losers, you can get the Canada Revenue Agency to share your pain.

If you were in a high tax bracket ( let’s assume a top marginal rate of 46 per cent), that $15,000 would have generated a $ 6,900 tax refund when the money was originally contributed to your RRSP. Had the $ 15,000 grown, as you hoped, to $30,000, then the CRA would have shared your pleasure when it came time to withdraw the funds — either voluntarily, when you’re in a low tax bracket, or after age 71, when the RRSP is converted to a Registered Retirement Income Fund (assuming that is chosen). If you withdraw while in the same high tax bracket, then you’d owe the CRA 46 per cent of $30,000, which is $13,800.

But, if instead your $ 15,000 sinks to $ 5,000, when it comes time to withdraw the CRA will be as devastated as you over your loss. And, if you choose to withdraw the stocks when you’re in a lower tax bracket — as may occur if you’re semiretired and not yet drawing down pensions and registered investments — you may come out ahead compared to waiting until you’re forced to withdraw RRIFs when you’re in a higher bracket.

The investment adviser who tipped me to the “liberate your losers” plan says the strategy is nothing like the dubious RRSP meltdown advocated by some. It’s the “revenge of the bear market,” he says.

By moving the “losers” to a non- registered account, you still own the stocks, so are happy if they finally start rising in value. And, if they do, the CRA will only get half the take it would have received had they risen in the RRSP, because of the 50 per cent capital gains inclusion rate ( in an RRSP, any gains would have been fully taxable as income). And, the adviser points out, you could deny the CRA even the capital gains by doing a second transaction, post-liberation: contributing the stocks to a tax-free savings account.

I recently liberated three losing Canadian stocks and two U. S. ones from my discount brokerage RRSP. Note that you will probably have to phone your financial institution to do this, but I found it relatively painless. The rep who handled it for me knew the process well and told me it was quite common.

Because you are deregistering some of your RRSP, you will have to pay withholding taxes: 10 per cent, if less than $ 5,000; 20 per cent if between $ 5,001 and $15,000; and 30 per cent beyond that. Your RRSP trustee will handle that for you automatically. But even after that tax hit, you should come out ahead: You’ve merely gotten a head start on your next set of taxes payable. The final tax tally won’t be apparent until you file a year from now. Odds are that if you’re in a lower tax bracket than when you first contributed ( probably at a much higher rate), you may be pleasantly surprised. And if your liberated losers DO make a belated comeback after all this, you’ll be all smiles.