Well after thinking about it for a few days I think I have worked out my plan to not invest an additional funds in my wife's RRSP other than my current $100/month.
It comes down to taxes.
Situation #1 - In the RRSP (Spousal)
Let's say I put in $1000/year additional to my wife's RRSP. That would generate a $350 refund on my taxes which I would roll over to the RRSP. So I keep doing that I would average $112/month at 5% for 15 years I would get about $32,050. I would get tax free growth until I hit 45 but then we would start paying tax on all the gains and the original investment to the tune of about 26%, or about $8333 of that. So her nest egg after tax would be $23,717.
Situation #2 - Outside the RRSP in my spouses investment account.
In this case the wife invests $1000 in a Canadian Blue Chip stock. Dividends would be taxed at a -5% rate, so better than tax free growth and then once she sells she would only pay capital gains at a rate of about 13%. So we kept putting in $1000/year or $83/month and she got dividends to a tune of 1% for a 6% rate of return she would have $26,592 in 15 years. Now tax in this case is only on the capital gain, so drop off $15,000 for monthly investment to $11,592. Then drop the reinvest dividends for another $115 to $11,477 at a 13% tax rate, she would owe $1492. So the nest egg after tax would be $25,099.
So outside the RRSP beats inside by $1382 and I did not include any bonus for getting that -5% tax on the dividends outside the RRSP.
I should point out those numbers were made with a lot of assumptions (like all numbers are in current dollars, that the wife doesn't sell the stock early and trigger a capital gain, and that any RRSP withdrawals would be fully taxed), but with numbers like these you have to make some assumptions otherwise you can't come up with anything. I still feel that having an RRSP is a great idea for those investments which are tax equal to income like interest or holding non- Canadian stocks.
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8 comments:
What is -5% taxation rate?
If you look at www.taxtips.ca, and find the tax rate page for SK. You will notice that the lowest tax bracket gets an effective tax rate of -5% on dividends. There should be a page on the site that gives a fairly good explanation on how that works.
CD
Shouldn't you also take into consideration how long before you want to withdraw from the RRSP? If it's a longer time period, the tax free growth could be worth your while. Also, wouldn't it make sense to put some into the RRSP. You could withdraw from the RRSP first and not your non registered account. That way, you could potentially reduce the amount of taxes you pay later?
I just started reading your blog and it's really inspiring. My target for retirement has always been 55...
If you wife is in the lowest tax bracket, wouldnt' it make sense to keep her investments outside an RRSP?
FT
I have a few minor quibbles with your examples. In #1 you omit the basic personal exemption from your calculations. Assuming you cashed out the spousal all at once I figure your actual tax bill will be under $6000 not $8333. I suspect your two examples would come out much closer than your calcs work out to. If your wife is working she may have "used up" the basic exemption already and this would be a moot point.
Also keep in mind that while we have the benefit of negative taxation on dividends here in SK, the dividend gross-up will negatively affect things like your GST/PST rebate, OAS (when you collect it) and other social benefits that are based on an income test, like the prescription drug assistance that is available here in SK if your drug costs are high in relation to your income.
Pragmatic - Yes I considered how long before the withdrawl, which is why I picked 15 years as a baseline. You do bring up a good idea about taking the RRSP first. If I withdraw out of the RRSP first up to the personal limit (as mentioned by Ghoststryder) and then took the rest of the required funds at captial gains and dividends. That would most likely produce the most income with lowest tax.
So perhaps a hybrid approach is the best overall. I would keep buying spousal RRSP to get the max tax refund for my dollar, but keep the purchases to more international funds and interest products like bonds. Then buy blue chip canadian stocks in my wife's taxable account.
Ghoststryder - You do bring up a good point of having to watch how the grossed up dividend to see how it would affect my other benifits. For the time being, it does nothing since my income is too high to get anything from the government. Yet in retirement this will be important. Which is why I am buying spousal RRSP's in the first place. I will be getting a pension at 55, while the wife will not. I'm not sure this pension income spliting is going to continue, so I'm trying to stay flexible in my planning.
Thanks for all the questions and great ideas everyone.
Maybe someone could comment on a strategy I'm developing. My wife is older then myself, and has stopped working. We plan to start withdrawing from her RRSP account in three years to reinvest it in a Corporate Class Fund. Is this a sound investment plan. I figured it would be taxed lower at this point. When the RRIF point approaches we won't be forced into taking larger sums of money at a higher tax rate.
Anon,
Could I get a bit more detail of what you are planning on doing and your situation? For example, ages would help and what other income your wife current has and what pension incomes you expect to have. Right now there are too many variables to comment on this. If you feel like it send me an email (candian.dream.free.at.45@gmail.com).
CD
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