Sadly, Tim’s dad just passed. Happily, he was a smart guy. “He bequeathed my mother, in her 70s, with his RRSP savings totaling almost $700,000,” says the son. “It’s growing rapidly and my frugal mother can’t take money out fast enough to touch the principal.”
So what’s the problem?
“When she passes on this RRSP money to her kids, the whole lump sum become instantly,” says Tim, “fully taxable (at the max possible rate). To avoid having the estate effectively cut in half we are looking for ways you can help “rescue” money from this ticking time bomb as quickly as possible. Are there ways of shifting RRSP money between non-spouse family members? Things other than the HBP which allow RRSP money to be extracted without penalty?
“No, this is not a greedy child counting his inheritance early. The whole family (Mother, son, daughter) just don’t want to see the government take half of my father’s hard-earned money in one foul swoop.”
I post Tim’s letter for a couple of reasons. Sure, it’s possible to move some of the money around and ‘rescue’ it from being fully taxed on mom’s demise – but the process is complicated and involves leverage. If mom borrows a big pile of cash, invests it, then takes RRIF income to pay the loan interest, over time capital will be moved from the shelter. (The RRSP income is taxable but the loan interest is tax-deductible.)
However, lenders aren’t keen on handing over big wads of leveraged cash to seventy-somethings with weensy incomes. So scratch that.
The real reason Tim is on this blog is to demonstrate the fallacy of RRSPs. They don’t eliminate tax. They defer it. Yet people come to think of all the money in a retirement plan as theirs. In this case the family – widowed spouse and kids – see the $700,000 pot as a family asset – their father’s ‘hard-earned money.’ But it’s not. It’s an illusion.
Dad got a tax break for putting money into the plan. He was allowed to grow it in a tax-free environment. He was even permitted to pass it on to his wife without being taxed. It was always intended to be withdrawn to pay for his or her retirement years, not to establish a tax-free legacy for hungry offspring. And a big whack of it was always the property of the government, which must be repaid.
It’s the covenant you make with the devil when you open an RRSP. In return for refunding the tax on your contributions now, you pledge to return it later, plus tax on the growth. You also agree to it being taxed as income (100%), not capital gains or dividends (50%). And if you die before this happens, the whole shebang is taxable – as if cashed in on the day of your passing.
This is the reality for every self-directed RRSP. Every group defined-contribution plan that your employer matches. Every registered pension plan. It’s all taxable. Same as money extracted from an RRSP for a condo down payment or to go back to school. In the end you’ve just kicked the tax can down the road. Better tell the kids now.
This is why TFSAs will come to be the retirement vehicle of choice. No, there’s not a tax refund when you contribute, but neither is there tax payable when you withdraw. All of the growth (like an RRSP) is not taxed. But that growth (unlike an RRSP) also flows into your hands in a taxless state. And TFSA money (on death) flows to a spouse or beneficiaries without triggering tax.
So, remember what I said yesterday about taxation on stupidity?
Here’s what I mean: these days only 15% of people make their full TFSA contribution – which would amount to a lousy hundred bucks a week. The participation rate has plunged dramatically since the thing was introduced back in 2009. That year two-thirds of people with a TFSA put in the max, but that was apparently because they just shifted their bank account into the next vehicle. Since then the savings rate has fallen off the map.
Worse (as I keep yelling ya) 60% of this money is in cash and another 20% is in GICs. People treat TFSAs like glorified savings accounts for Cuban holidays, new taps or liposuction. Even the government has produced ads telling you the tax-free account is a great way to finance a kitchen reno. (It’s in politicians’ interest to keep you stupid, by the way. The more growth a TFSA creates, the less tax that’s paid.)
No wonder the lefties are mobilizing to stop the doubling of the TFSA contribution limit. When 85% of the benefit is being squandered by the masses, they’re loath to see the rich (who all read this blog, of course) get even more of a break. Sure, they could participate. But it’s easier to buy a house they can’t afford, then moan about unfairness.
This is akin to thinking your father’s RRSP belongs to you, and asking Garth to rescue it.
What a waste that is.
In case you hadn’t noticed, this is a nation designed for rich people.
If I earn $180,000, am single and live in BC, I’ll pay $39,848 in federal tax and $19,419 to the province. The tax bill totals $59,267. The leaves me with $120,733, and on every extra dollar earned, I’ll be taxed at the rate of 45.8%. Ouch.
But if I have an investment portfolio of $2,600,000 and earn 7% in capital gains in a year, then of the $182,000 received I’ll pay only $21,436, and end up with more than $160,000. So, I keep an extra forty grand. Because I’m wealthy.
This happens since capital gains are taxed at only half the rate of earned income. Ditto for dividends, because by claiming the dividend tax credit rich people reduce their government bill by approximately 50%. Or sometimes, 100%. Somebody with a portfolio of $1.2 million in bank stock kicking out about $48,000 in annual dividends (an average of 4%) would end up paying zero tax. That’s right. Nothing. But if you earned $48,000 in Ontario working as the personal masseuse to a Re/Max broker, you’d pay just over $8,000 in tax.
See? Totally unfair. That’s why rich people invest money instead of earning it doing tawdry things like working. Employees are sitting ducks for government Hoovering, and the top marginal tax rate now exceeds 50% in Ontario. But for business owners taking their income as dividends or capital gains, it’s party time.
Now, employees do get a few breaks. Money put into an RRSP allows you to defer the tax on it until a year in which you make less and your marginal rate drops, for example. Plus the growth compounds without annual taxation. But RRSPs only defer tax. They do not eat it. And this brings us to the TFSA, which is suddenly in the news – for good reason.
As this pathetic blog has shown you in the past, a simple TFSA can be a money machine, so long as you use it to hold cool stuff like ETFs, and not brain-dead flotsam such as GICs. If a 30-year-old put in a hundred bucks a week until age 65, getting an average annual 7% in taxless growth, she’d end up with $848,776. Unlike an RRSP, this is completely non-taxable.
Now imagine if the annual contribution limit was $11,000. Then this same person, at retirement, would have $1,783,919. That’s enough to generate an annual cash flow of $125,000 (without diminishing the principle), which you can take as non-reportable income. That means you still get to collect your government pogie, no clawback.
This is what drives the 99% crazy. It’s inherently unfair.
If you buy a condo and lease it out, the rent is fully taxed as income – on top of any other money earned, at your full marginal rate. Interest earned on a GIC, bond or savings account gets equal treatment. Investors in ETFs, stocks or preferred shares, on the other hand, pay half. And guess where most TFSA money sits? You bet – in interest-earning cash or investment certificates.
In other words, the system taxes financial illiteracy. Employees and savers are squished. Owners and investors are favoured. Concurrent with this, the 99% carry most of the debt in Canada, largely because they’ve drunk the real estate Kool-Aid. All that borrowing eats disposable income, leaving little left to invest.
Well, you can see now how emotionally-charged the debate about doubling the TFSA contribution limit can become. The federal Conservatives promised this back in the election of 2011, and Joe Owe was all primed to deliver it until oil swept away his winter budget. It’s still the big middle class carrot the government would like to toss out before the October election campaign gears up.
Opposition is growing. The Parliamentary Budget Officer weighed in this week, saying the action would end up costing the feds almost $15 billion in lost tax revenue by 2060 – when this blog will finally hits its prime. Moreover, it would favour the rich. “By 2060, gains for high wealth households project to be twice the median and ten times that of low-wealth households,” he said. This was reinforced by SFU professor Rhys Kesselman, who claims: “Like a little baby who looks cuddly and cute, this proposed initiative would grow up to be the hulking teenager who eats everyone out of house and home.”
This is all correct. Smart, wealthy people milking the TFSA can save a fortune in tax over their lifetimes. But the same has been true of RRSPs for years, since contribution room is based on income – the more you make, the more you can contribute and the greater the savings because of the higher tax rate you pay.
So what’ll happen?
Beats me. But if the feds can eke out a balanced budget this year, the TFSA bloats. As it should. The more we allow people to create and shelter wealth, the more that precious public resources can be targeted to those who need them. (Which is why the OAS should not be universal.)
Besides, people are victims of their own fear or ignorance. The nation gives them RRSPs, and they use them for house down payments. They get TFSAs, and they turn them into growthless savings accounts. They’re offered half-tax on investments, but they buy GICs. They get a huge gift on dividends, and they want a rental condo. The country drops rates, and they cannot borrow enough.
It’s not about fairness any longer. It’s about taxing stupid.
See why I’m no longer elected?