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Private Investment Advice

Reaching beyond the RSP barrier

Higher-income earners should focus on saving both inside and outside an RSP

With its tax-deductible contributions and tax-deferred savings, the registered Retirement Savings Plan (RSP) is the foundation of retirement savings for most Canadians.

And for good reason. It’s arguably the most valuable tax deferral method around, and it’s available to every Canadian who has earned income.

An RSP is just one part of a retirement savings strategy, especially for higher-income earners.

Once you’ve maximized your contribution, you should look at opportunities beyond your RSP. Fortunately, there are tax strategies available here as well.

Tax-Free Savings Account

The recently proposed Tax-Free Savings Account (TFSA) will be an excellent complement to the RSP when it comes into effect in 2009. It will allow Canadians, 18 years of age or older, to contribute up to $5,000 of after-tax income per year to a savings account. The growth and withdrawals will be tax-free. In addition, once the funds are withdrawn, they can be re-contributed in a future year.

The advantages of equities

Equities, or stocks, offer a number of tax advantages:

Capital gains

The increase in value isn’t taxed until you realize the capital gain by selling or transferring the investment, at which time 50% of the capital gain is taxable. In effect, you can defer the tax hit for many years with a buy-and-hold strategy.


Dividends paid to shareholders by taxable Canadian companies qualify for the federal Dividend Tax Credit, which reduces tax payable. Income from dividends is taxed at a lower rate than regular income.

Some common shares, and most preferred shares, pay dividends (the latter typically providing a higher dividend percentage). So, holding preferred shares outside your RSP brings you the greatest benefit.

Real estate

The principal residence exemption is the best real estate related tax break. Any increase in the value of your principal residence is tax-free when you sell.

Additionally, if you sell real estate (other than your principal residence) for more than you originally paid, the increase in value is subject to capital gains tax. And while rental income is fully taxable, you can deduct expenses incurred to earn the income generated and claim Capital Cost Allowance (CCA).

Alternative Investment Vehicles

Some vehicles such as Real Estate Investment Trusts (REITs) and Royalty Trusts, attempt to gain tax efficiencies by passing on the benefits of their respective industry tax credits to investors. These investments are complex, and expose investors to special risks. Be sure to talk to your advisor before taking part in these types of investments.

Labour-sponsored funds encourage investors to support small, riskier, business ventures by awarding preferential tax treatment. A federal tax credit of 15% of the amount invested is available on investments of up to $5,000 a year.

Some provinces offer their own credits, in addition to the federal one.

However, most labour-sponsored funds have a minimum hold period. Failing to hold the fund for this period means you must repay the tax credit.

These funds are complex, and should be discussed in detail with your advisor before purchasing.

Funds can be fundamental

In addition to buying individual stocks or bonds, many investors invest through mutual funds so that they can enjoy professional management and diversification, along with the potentially substantial tax benefits.

Equity funds often distribute realized capital gains annually to unitholders. Outside an RSP, these distributions are taxable, even if you receive them in the form of additional fund shares rather than as cash. Funds that have low turnover will realize lower capital gains, thereby distributing fewer gains to unitholders. If you have both RSP and non-RSP accounts, you should consider holding higher turnover funds inside your RSP, and lower turnover funds outside.

First things first

Equities, real estate, REITs, royalty income trusts, and mutual funds can play an important role in your retirement savings strategy. But before you begin to explore them, make sure that you’ve taken full advantage of the tax-deferred power of your RSP.

Contribute the maximum: We’ll state the obvious first. More than 70% of all Canadians do not contribute the maximum amount to their RSPs each year. If you’ve let your RSP contributions slide, it’s time to play catch up. That means not only contributing the maximum amount this year, but also making use of any contribution room that you’ve carried forward from previous years.

If your current cash flow presents a problem, you might consider an RSP loan to contribute the maximum or make a catch-up contribution.

Today’s low interest rates make the cost of borrowing quite reasonable, and, in many cases, the tax-deferred returns on the money you invest will be greater than your borrowing costs. You can lower your costs even further by using your tax refund to pay down your loan.

Consider a spousal RSP: If you’re married or living common-law, a spousal RSP can generate significant tax savings after retirement, while also delivering an immediate tax deduction.

With a spousal RSP, one spouse contributes to an RSP in the name of the other spouse. The contributing spouse receives the immediate tax deduction. At retirement, withdrawals from the spousal RSP are taxed in the hands of the planholder, not the contributor. Any contributions made in the three years prior to a withdrawal are taxed in the hands of the contributor.

Spousal RSPs are one of the most effective ways for a couple to split income in retirement, and possibly reap significant tax savings.

A couple with a household income of $100,000, for example, will pay far less tax if each spouse earns $50,000 rather than if one spouse earns the full $100,000.

Split pension income: couples can split 50% of their pension, RSP or RIF income, potentially resulting in significant tax savings. In order to split RSP or RIF income, the individual must be at least 65 years old.

Whether you’re investing inside or outside of your RSP, your TD Waterhouse Investment Advisor can help you take full advantage of all suitable options.

For residents of CANADA only.

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