Normally, you want to choose RRSP investments that maximize returns 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 willing to take more risks. Then they 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. Income earned and capital gains realized in your RRSP are not taxed until they are withdrawn from your plan, usually after you retire.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, the preference is 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. There is also a preference to hold stocks and other investments that produce eligible dividends outside of your RRSP due to the lower tax rate that applies on these dividends when compared to ineligible dividends or interest.
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, paying tax on the capital gains upon disposition will reduce the funds you have to invest. Therefore, from a tax perspective it makes sense to hold short-term stocks in your RRSP, where the tax on capital gains will be deferred, and to hold long-term stocks outside of your RRSP.
Keep in mind that short-term stocks are usually riskier. This 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 the RRSP available to you in your retirement.
The primary concern in choosing investments for your RRSP should be to maximize returns while staying within your risk tolerance. However, tax can play a part in making these investment decisions. Contact your BDO advisor if you have any questions about the tax implications of the investments in your RRSP.
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 October 1, 2019.