RRSP Question

[darklord700]

I have a RRSP and a TFSA account and I have stocks in both of them. I focus on dividend paying stocks, Royal Bank, BCE etc. Naturally, the dividend tax credits are lost for stocks held inside RRSP. So how can I avoid that?

I won’t have money left over to invest in a non-registered account after maxing out my RRSP, TFSA, RESP and paying down my mortgage and car loan.

I already hold only stocks in TFSA and since the TFSA balance is much smaller than RRSP, I can’t load up TFSA with stocks anymore.

I don’t want to invest in low paying GIC only in my RRSP and I want to keep aggressively investing in high quality dividend paying stocks for growth.

My only conclusion is to enjoy the capital appreciation of the stocks inside my RRSP and forget about the loss of dividend tax credits. Do you think there’re other ways to improve my aggressive investment strategy? Thanks.

[MoneyGuy]

Talk to Slava
/thread

[mrkajz44]

There is no magic answer of course. The one thing many people seem to overlook on RRSPs is they are taxed eventually as normal income when extracted during retirement. So while the capital gains earned are not taxed while in the RRSP per se, they are taxed when extracted at 100%, rather than at the capital gains rate of 50%. The offsetting benefit to this is the long tax deferral an RRSP offers.

All in all, if you are not maxing out your RRSPs and TFSAs (i.e. no non-registered investments) it's hard to go wrong with any strategy.

[Ducay]

Dividend tax credits are partially offset by the gross up you have to take on them. You'd be paying tax on the dividends if they weren't in your RRSP, so point is moot if the money is already in your RRSP. Its locked in and you basically want it to earn as much return as you can with it.

[Slava]

Originally Posted by darklord700

I have a RRSP and a TFSA account and I have stocks in both of them. I focus on dividend paying stocks, Royal Bank, BCE etc. Naturally, the dividend tax credits are lost for stocks held inside RRSP. So how can I avoid that?

I won’t have money left over to invest in a non-registered account after maxing out my RRSP, TFSA, RESP and paying down my mortgage and car loan.

I already hold only stocks in TFSA and since the TFSA balance is much smaller than RRSP, I can’t load up TFSA with stocks anymore.

I don’t want to invest in low paying GIC only in my RRSP and I want to keep aggressively investing in high quality dividend paying stocks for growth.

My only conclusion is to enjoy the capital appreciation of the stocks inside my RRSP and forget about the loss of dividend tax credits. Do you think there’re other ways to improve my aggressive investment strategy? Thanks.

Well the short answer is there isn't much you can do about it. You either shelter the growth in an RRSP or don't and get the dividend tax credit for the dividends.

Originally Posted by mrkajz44

There is no magic answer of course. The one thing many people seem to overlook on RRSPs is they are taxed eventually as normal income when extracted during retirement. So while the capital gains earned are not taxed while in the RRSP per se, they are taxed when extracted at 100%, rather than at the capital gains rate of 50%. The offsetting benefit to this is the long tax deferral an RRSP offers.

All in all, if you are not maxing out your RRSPs and TFSAs (i.e. no non-registered investments) it's hard to go wrong with any strategy.

This is true of course, but theoretically at least the plan is to be in a lower tax bracket at retirement.

[Calgary14]

If you've maxed out your RRSP and TFSA as well as aggressively paying down your mortgage you're in a good position. If you're into div stocks I would definitely consider the smith manoeuvre which is essentially a HELOC used to buy equities and the interest on the loan is tax deductible. This is assuming of course you have no consumer debt. If your car loan int rate is high - pay that off ASAP

[darklord700]

Thanks for your replies. Guess there's no way getting around losing the DTC inside of RRSP. Like Ducay pointed out, the DTC is not 100% lost as you don't gross up dividend inside of RRSP account.

Even if I have an unregistered account, there's no way I am going to hold 100% low interest rate GIC or Bonds inside of my RRSP account so this problem will follow me forever. But as the corporate tax rates are low right now, the lost of DTC isn't that much comparing to when the corporate tax rates were higher.

[Calgary14]

Originally Posted by darklord700

Thanks for your replies. Guess there's no way getting around losing the DTC inside of RRSP. Like Ducay pointed out, the DTC is not 100% lost as you don't gross up dividend inside of RRSP account.

Even if I have an unregistered account, there's no way I am going to hold 100% low interest rate GIC or Bonds inside of my RRSP account so this problem will follow me forever. But as the corporate tax rates are low right now, the lost of DTC isn't that much comparing to when the corporate tax rates were higher.

I agree and I wouldn't bother with a GIC or bonds inside a TFSA since the rates are so low. If you've maxed out both your RRSP, TFSA and have managed to put more money towards your mortgage, you don't need to worry about the DTC

[darklord700]

Calgary14, I've checked out the Smith Manoeurver. And my thinking is in this low interest rate envirornment, the tax saving does not justify the added risk of leverage. I pay 3.5% on my HELOC so even at the highest tax AB bracket, I save 1.365% on tax. In reality it's going to be less than that becase there's got to be some additional transaction fees and I still end up paying tax on the Dividends I received. I doubt at the end, I'll save anything if at all. Do you agree?

[photon]

How did you come up with the 1.365%? Wouldn't how much you save on tax depend entirely on your income and the size of your mortgage? If the HELOC is worth say $250,000, that's a $8,750 tax deduction, which may be huge or very little depending on your income.

[darklord700]

Photon, the saving is between deductible and non deductible interest expnse. HELOC or mortgage interest are normally not deductible in Canada and the Smith Maneouver is an attempt to make this interest tax deductible. So the saving at the top AB tax rate is, in my example, 3.5% (HELOC rate) X39% (tax rate)=1.365%.

There'll be added costs and leverage risk to run a scheme like the Smith Maneouver so your net saving is going to be less than 1.365% in my example.

If you belong to the lower tax bracket, your savings are going to be even less than that.

[photon]

Lets take my example, guy owns a house with a $250,000 mortgage, which he's completely converted to investment. The interest on that is 3.5%, $8750.

Guy makes $100,000 gross, assuming no other factors his tax payable will be $26,981.60 which leaves after tax income of $73,018.40, an average tax rate of 26.98%.

So after this he can deduct $8750, which reduces his taxable income to $91,250, so tax payable will be $23,831.60 which leaves after tax income of $76,168, an average tax rate of 23.83%. That's 3.15% difference average tax rate. $3150 less taxes paid.

Multiplying those two numbers that way doesn't feel like it's a meaningful number, but I can't put my finger on why.

[darklord700]

Your math is right. By making 8750 deductible at the $90K tax bracket of 36%, you pay 3150 less taxes (3150/8750=36%). It's hard to reconcile the average tax rate difference as you have $82K or so of income tax effected at different rates.

So 3150 savings on $250,000 mortgage is a saving of 1.26% (3.5% interest rate x 36% tax=1.26%).

[photon]

I think I see what you mean, you had said "I save 1.365% on tax" which to me just means take your tax and lop 1.365% off the top. Where it maybe should have said "I save 1.365% of my mortgage off my taxes".

If it was a $400,000 mortgage then that's $5000 a year, nothing to sneeze at IMO.

But you are right it's not without risk, if you run the whole thing with a 0% return on investments scenario then you end up further ahead with mortgage paydown I think so it does have to have some level of return in order to work. But the difference isn't so vast that even in a no-return for investment scenario will you end up hugely behind.

[Slava]

Well the low rates mean you save less, but it also means you need less of a return to break even. So using this rate, you can invest in almost anything and make money.

[darklord700]

Originally Posted by Slava

Well the low rates mean you save less, but it also means you need less of a return to break even. So using this rate, you can invest in almost anything and make money.

I just did some research. Assuming 3.5% HELOC rate, you need at least BBB rated coporate bonds to make 3.5% from companies like Translata, Fairfax Financial, Brookfield etc. Higher grade investments like T bills or GIC won't get you anywhere close to 3.5% yield.

I can kind of stomach buying bonds from these companies but the problem is all these bonds are selling at a premium right now. Meaning you'll pay 100% tax on the interest but will only get capital loss treatment when the bonds mature.

Many quality div stocks will give you 3.5% yield but you have to bear the risk of the stock prices fluctuation.

[Slava]

Originally Posted by darklord700

I just did some research. Assuming 3.5% HELOC rate, you need at least BBB rated coporate bonds to make 3.5% from companies like Translata, Fairfax Financial, Brookfield etc. Higher grade investments like T bills or GIC won't get you anywhere close to 3.5% yield.

I can kind of stomach buying bonds from these companies but the problem is all these bonds are selling at a premium right now. Meaning you'll pay 100% tax on the interest but will only get capital loss treatment when the bonds mature.

Many quality div stocks will give you 3.5% yield but you have to bear the risk of the stock prices fluctuation.

Well, I'm not trying to sell you on leveraged investment here, but your break even is less than 3.5% because you have 39% of that covered with the taxes saved. So now you're talking about a break even of say 2.14%. A five year GIC would get you more than that (although you have to account for taxes on that gain as well, which takes you under). You can get dividends over this for sure though, and they're better tax wise, as you know. You're right that you have to be wiling to bear the risk though, and with leverage that's always the biggest factor.

[calgarywinning]

Solid advice from Slava on dividend paying investments.

[Calgary14]

Originally Posted by darklord700

Calgary14, I've checked out the Smith Manoeurver. And my thinking is in this low interest rate envirornment, the tax saving does not justify the added risk of leverage. I pay 3.5% on my HELOC so even at the highest tax AB bracket, I save 1.365% on tax. In reality it's going to be less than that becase there's got to be some additional transaction fees and I still end up paying tax on the Dividends I received. I doubt at the end, I'll save anything if at all. Do you agree?

The smith manoeuvre basically works like this: take out a HELOC to ensure you have the cash to invest. Use the HELOC to buy dividend paying equities (or rental property). Deduct the total annual interest paid from your taxes (in the HELOC). So if you're HELOC was for $100k and you paid 3.5% you would deduct $3500 interest. Use both the div income and tax refund to put towards the original, non deductible mortgage.

I'm not advocating leveraging either but this works due to low interest rates, the deductibility of the interest and the div tax credit. The end goal is to use the income from the HELOC to pay down the non deductible mortgage. You need to be comfortable with both your cash flows and leveraging. If interest rates go up - this strategy sucks.

One piece of advice: don't make an investment based on the tax breaks, invest because you believe it's a solid investment. The best, fastest and simplest way to increase net worth is to eliminate all non deductible liabilities (ie your original mortgage)

[darklord700]

I am a bit confused about SM now. In the simplest form, it entails borrowing at a lower rate and hope to earn at a higher rate and use the proceed to accelerate the paying down of mortgage. This is par for course and a lot of people are doing it now.

What SM brings new to the table is to increase borrowing everytime you pay down your mortgage's principle amount to turbo charge the process. That's fine as well but I just don't see how this is making the non-deductible mortgage debt tax deductible. Anyone cares to enlighten me? Thanks.