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Sheltering RRSP/RRIF Withdrawals

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RRSPs RRIFs and TFSAs   ->   Stocks, Bonds etc.   -> Get Money out of RRSPs Sort of Tax Free

How to Get Your Money out of RRSPs Tax Free (Sort of)

Unfortunately, there is no way you can avoid tax when withdrawing money from RRSPs or RRIFs.  But, with some tax planning, you can reduce the taxes payable.

You can do this by borrowing money to invest in Canadian dividend-paying stocks outside of your RRSP, while you make withdrawals from your RRSP.  This is the same strategy used in borrowing to invest.  It converts a portion of your RRSP withdrawal income, which is fully taxed, into eligible Canadian dividends and capital gains, which are taxed at lower rates and/or allow you to defer tax. This is done by offsetting a portion of the RRSP withdrawal with the interest expense on the funds borrowed to invest.

Of course, you would have to borrow a significant amount in order to achieve the tax savings.  We do not recommend this strategy unless you are an experienced investor!  At times the stock market is very volatile, and if you have no experience you may panic and make bad decisions. Individual stocks and ETFs will rise and fall continually, and the whole portfolio will suffer a large drop (10% to 20%) approximately once a decade. For more on this, please read our article Risk as it Relates to Investing.  Our advice is to slowly invest in stocks, work your way up to borrowing to invest, and then use this strategy when you retire, or start shortly before you retire.  By the time you're ready to do this you should have a well-diversified portfolio of investments already.

Naturally, this tactic depends on the margin borrowing rate as well as the rate you're achieving for dividends on the investments purchased.  Keep in mind that the balance owed can be reduced by dividends received and tax savings.  The dividends normally increase over time, as long as good quality (blue chip) stocks are purchased.  The market value of the stocks also will increase over time, and including dividends the average return should be approximately 8 to 9% per year.  We update our return every year in our Free in 30! article.

Please also read our article Interest Expense on Money Borrowed to Purchase Investments - Can I Write it Off?  In most cases, the interest on the debt is only tax deductible as long as you own the stocks.  Note that if a corporation has a stated policy that it will not pay dividends, interest on funds borrowed to buy shares of that corporation will not be deductible.

Tax Tip:  Keep a separate brokerage account for investments purchased with borrowed funds, to ensure a clear paper trail for interest deductibility.

Example:

Let's consider an Ontario taxpayer who has full OAS (approximately $7,200) in 2019, $4,800 of CPP retirement income, and $50,000 of eligible pension and other income, so a total of $62,000 of taxable income.  This would include whatever is withdrawn from the RRIF.  The income tax payable on this $62,000 of taxable income would be $11,183.

The taxpayer borrows $200,000 on margin at a rate of 4.25%. They invest in Canadian stocks paying eligible dividends, with an average yield of 4%.  In the first year, interest expense is $8,500 and dividend income is $8,000.  Although this example shows borrowing and buying $200,000 all at once, the best way to invest is gradually over a period of time.  See the difference in income tax using a marginal tax rate of 32.7%:

  Income Taxable Tax
Income/Tax  $62,000 $62,000 $11,183

 

  Income Taxable Tax
Income $62,000 $62,000 $11,183
Add Dividends 8,000 11,040 3,610
Less Interest (8,500) (8,500) (2,780)
Subtotal 64,540 $12,013
Dividend Tax Credits (2,762)
Total Tax Payable $9,251
Net Tax Savings 1st Year $1,932

    - You have $500 less net income, but you pay $1,932 less tax, leaving a net saving of $1,432.

    - Dividends increase by approximately 5% per year ($8,000 +5% =$8,400).

    - Interest rates can vary.

    - Value of the stocks should increase by an average of approximately 4 to 5% per year (8 to 9% return less 4% dividend).  A 4% to 5% increase would be $8,000 to $9,000 increase per year.

    - May be wise to pay down the debt with the tax savings until the dividends increase enough to reduce the debt.

See our recommended portfolio for Canadian stocks in a non-registered account.

If you're seriously considering this strategy, it's important to read the following articles:

    - Recommended Stocks

    - Borrow to Invest

    - Borrow to Invest Calculator

    - Risk as it Relates to Investing

    - Interest Expense on Money Borrowed to Purchase Investments - Can I Write it Off?

Tax Tip:  Borrowing to Invest is a good strategy for experienced investors, but be careful, and keep excellent records!

Revised: May 29, 2019

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