RRSP meltdown

An RRSP meltdown is a strategy some financial advisors suggest as a way to withdraw money from an RRSP while paying little or no income tax.

In the simplest form, you set up an investment loan and make the interest payments from RRSP withdrawals (the withdrawals must be equal to the interest payment). Since the interest on the loan is tax-deductible, the tax on the RRSP withdrawal is cancelled out. This, in theory, results in zero tax owing on your withdrawal.

You use the investment loan to buy dividend-paying stocks, which provide you with income during retirement. Dividend-paying stocks also have the advantage of being very tax efficient.

However, often RRSP meltdown arrangements involve making RRSP withdrawals and placing the money in business or real estate deals that generate large tax deductions. These then offset the taxable income from the withdrawals.

The investor who has participated in the RRSP meltdown is then left holding an illiquid, and often quite risky, investment. To generate the tax deductions, you may also have to take out or guarantee a large debt.

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Sometimes the deal “guarantees” the RRSP meltdown investor a steady income. But the guarantee is sure to be full of holes. The only things that are reliably guaranteed in these deals are the huge fees and commissions they generate for the salespeople and financial institutions involved.

I have looked at a number of these so-called RRSP meltdown deals over the years, and have yet to come across one that inspires my confidence.

No direct way to avoid taxes

There’s no direct way to take money out of an RRSP without paying tax at the rate you would have to pay on ordinary income.

You can make your contributions to a spousal RRSP. This way, when the money is withdrawn years later, it is taxed in the hands of your spouse, who may be in a lower tax bracket than you are. It’s also a good idea to plan things so that you use spousal RRSPs to split your retirement income between you and your spouse. This can lower the total tax burden on your retirement income as a couple.

Another way to lower the overall tax burden on your RRSP withdrawals is to make withdrawals in low-income years — even if you don’t need the money in those years. You’ll then lose the tax-shelter on future earnings, of course. But you may reduce your taxes in the long run, particularly if you invest your RRSP withdrawals in stocks that you hold on to for many years.

It’s possible to use your own RRSP funds to make a mortgage loan on a home you are buying and gradually pay it back to your RRSP. But in light of the fees involved, it may be cheaper to get a mortgage from a conventional lender.