Another question about retirement models from yet another baby boomer. Mr. B.M. is about to retire (age 61) and all of his retirement savings are in a self directed RRSP. Over the accumulation phase of his working life, he was never able to max out his contributions.

“It seems to me that I would likely optimize my taxes by systematically selling securities out of my RRSP and re-purchasing the same securities in a non-registered account. This would likely reduce the tax hit on the mandatory large later withdrawals, although I appreciate the tax sheltered compounding benefit.” Does this make sense, of am “I out to lunch?”

A couple of points come to mind. It was nice to read that Mr. B.M. had a real appreciation for the benefits of tax free compounding. That is not a widely held view, but from my perspective, it is the major benefit of RRSPs. 

Most investors typically deposit money into RRSPs thinking that the real advantage is the initial tax deduction. But when looking at things on a long term perspective, the initial tax deferral – it is only a deferral because you pay tax at your marginal rate when you withdraw the income – pales in comparison to the benefits of tax free compounding.

The second point relates to his quest to pull money from the RRSP in an effort to “optimize” his taxes. I gather from this statement that when he retires he will be in a low tax bracket. As such money withdrawn will be taxable in his hands at the lower rate. 

It is also apparent that he likes his current portfolio. Also he does not appear to need the RRSP withdrawals for his day to day living expenses, because he seems willing to re-purchase the same securities – i.e. the securities he would sell to generate the cash to allow for the RRSP withdrawal - at a later date in his non-registered account. 

On this point, Mr. B.M. does not have to sell and then re-purchase his securities. He could simply swap the securities inside his RRSP to his non-registered account. In the simplest sense, the non-registered account would be purchasing the security from his self directed RRSP account. The cost base for the non-registered account would be the purchase price from the RRSP. 

For example, say that the self directed RRSP was holding 1000 shares of Royal Bank with a cost base of $40 per share. The stock is currently trading at $54 per share. Let’s assume that Mr. B.M. wanted to take $16,200 into income through a withdrawal from his RRSP. He could sell 300 shares of Royal Bank inside his RRSP and then withdraw $16,200. There would of course be the customary withholding tax on this withdrawal. 

However, assuming that Mr. B.M. wanted to continue holding Royal Bank, he could simply swap 300 shares from his RRSP to his non-registered account at a cost base of $54 per share. The RRSP would be responsible for the gain from $40 to $54, which because it is inside the RRSP would be a moot point. 

Mr. B.M. would still be responsible for the withholding tax, but assuming that the non-registered account is a margin account, he could fund the withholding tax with his excess margin. At least with this approach he eliminates the need to sell and then re-purchase at a later date. 

The next question asked if I knew of any software that could help Mr. B.M. optimize his taxes. I assume that to mean, is there software that would help him assess the maximum amount he could withdraw from his RRSP at the lowest tax rate. 

I am not familiar with tax software specifically related to that. Not to say it doesn’t exist! If readers are aware of such software, please feel free to write me. But it seems to me that a simply spreadsheet would probably deliver the answer that Mr. B.M. is seeking. 

For example, Mr. B.M. could simply go to CCRA’s website and download the most recent income tax rates for his specific Province. From that he would know how much income ha can take in at the lowest marginal rate. He would then subtract his current income from the maximum income in the lowest rate and what is left over is the amount that can be withdrawn from the RRSP. 

In this case Mr. B.M. says that he plans to live off strip bonds for the first ten years of retirement. He intends to simply cash them in when they mature. Given that, he may be able to take a sizeable amount from his RRSP, because with this strip bond strategy most of his income will be principal repayment, where there is no tax payable. A much smaller amount will reflect the interest income from the strip bond. 

In short Mr. B.M. is certainly not “out to lunch.” In fact he may be engaging in some shrewd long term tax planning strategies. Something that we could all benefit from.