Weekly Tax Tips
Should tax considerations affect my RRSP investment strategy?
9 Jul 2010
Normally, you will want to choose RRSP investments that maximize your return and stay within your risk tolerance. While equities hold out the promise of higher returns, they are more volatile than bonds or GICs. Most people prefer to hold a larger percentage of equities in their RRSP when they are younger and are willing to take more risks and then gradually convert to more stable, income producing investments as they near retirement.
Tax can, however, play a part in your investment decisions if you have investments inside and outside of your RRSP. Remember that income earned and capital gains realized in your RRSP are not taxed until they are withdrawn from your plan, usually after you retire. Therefore, from a tax point of view, there is a bias to hold income-producing investments such as GICs inside your RRSP as the interest income will be fully taxed if they are held outside of your RRSP. Similarly, it makes sense to hold investments that produce capital gains outside of your RRSP as tax only has to be paid on 50% of the gain. Also, there will be a bias towards holding stocks and other investments that produce eligible dividends outside of your RRSP due to the low tax rate that applies on these dividends.
You can break down your investment decisions from a tax perspective even further. Capital gains are only taxed when they are realized (that is, when you sell your investment). If you invest in stocks that you expect to sell in the short-term outside of your RRSP, capital gains will be realized that will be taxable, reducing the funds you have to invest. However, if you invest in stocks that you expect to hold for several years, any capital gains that accrue will not be subject to tax until you sell. Therefore, from a tax perspective, it makes sense to hold stocks that are short-term holds in your RRSP, where the tax on capital gains will be deferred, and to hold stocks that are long-term holds outside of your RRSP.
Keep in mind that tax advantages can sometimes conflict with other objectives for your RRSP investments. Although it may make sense to invest in stocks that are short-term holds in your RRSP, these investments usually are more risky and may conflict with your objective to have stable investments in your RRSP. In addition, if you incur losses on investments held in your RRSP, the losses will not be tax deductible—they will reduce the size of your RRSP that will be available to you in your retirement.
Your primary concern in choosing investments for your RRSP should be to maximize your return while staying within your risk tolerance. However, tax can play a part in making these investment decisions.
This tax tip is a publication of BDO Canada LLP on developments in the area of taxation. This material is general in nature and should not be relied upon to replace the requirement for specific professional advice. The information in this tax tip is current as of 9 Jul 2010.
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