In the future, your biggest tax bill will be your RSP taxes.
We all know of the benefits of tax refunds and tax-free growth for RSP, but what happens after you retire?
Here is how the RSP taxation works:
• Your RSP grows tax-sheltered until you draw out money. Any money you withdraw each year is considered “yearly taxable income” for tax purposes.
•If you wait to withdraw your money, the year you turn 72, your RSP turns into an RIF, which means that the government mandates you must withdraw at least 7.48% each year and pay tax on it. If you are married and you pass away, the RSP/RIF will simply transfer over to your spouse.
• The year the surviving spouse passes away, the entire value of the RSP/RIF is considered one year’s taxable income. If you have a $500,000 RIF left at that point, the government will take $212,000 in taxes!! This is often shocking to the estate.
How do you avoid this huge tax hit?
1. Don’t save so much in your RSP in the first place. Unless you are in the top tax bracket (and enjoying the maximum RSP refunds), saving too much now can lead to a massive tax hit at the end. In low income years, put less or nothing into your RSP.
2. Draw more money out while you are alive to enjoy it. From a pure financial perspective, you want to draw out registered money in years when it can be done at a lower tax rate – those years when you have very little other income. From a philosophical point of view, you want to draw out the funds when you are still able to enjoy it.
3. You can use strategies like the RSP meltdown to effectively draw out more money from your RSP by creating a tax deduction equal to the amount withdrawn. This strategy can be quite effective for many people, but does require some leveraged investing, and you might require professional advice.
The main message here is that you need to have a long-term tax minimization strategy, instead of simply saving up RSP funds.
One quick and free tool is the The Tridelta Retirement 100, which helps you see your likelihood of running out of money, your likely estate size and lifetime tax bill. By playing with RSP numbers, you can see the impact yourself.