Glancing at the final outcome first, you will notice that three of the options yield the same result and this is because the initial funds were already inside a tax sheltered account. Despite that, each of those three have a different outcome when the funds are withdrawn. A TFSA is 100% tax free as are qualifying withdrawals from an RESP or DRSP. As mentioned, every penny of the withdrawn amount from an RRSP is taxed because it is deemed income so this includes the original cost of the shares too. Being deemed income could adversely affect various income based tax credits and brackets.
At first blush, the investment account appears to have the worst ROI. This may be misleading as the final amount is “free and clear” when compared to either RRSP option where 100% of the amount is eventually taxed on withdrawal.
RRSP #2 assumes the investor deposited the initial capital into an RRSP and therefore receives the tax rebate for that deposit. One could withdraw funds from a TFSA and then deposit those proceeds into an RRSP for example if there were not sufficient funds available otherwise. A taxpayer in a 50% income tax bracket will pay 50% of the final RRSP amount on withdrawal.
RRSP #2 indeed yields the greatest observed result because of the tax rebate of the deposit. However, the entire withdrawn amount is taxable. It is not certain in this case what the investor did with their tax refund from the RRSP contribution – was it spent or was it deposited into any of the account options. If deposited into the RRSP the taxpayer is benefiting from a compounded or snowball effect. It is also possible that the entire rebate was used for non investment purposes (debt repayment, renovations, or a long overdue vacation). One cannot always put a true price tag on such uses of funds.
The above chart uses only the federal tax. The final numbers change once provincial or territorial income taxes are incorporated but that does not change the relative end result and it is the relative end result that is important.
But keep in mind that the registered accounts all have one thing in common and that is the letter “S” for “Savings”. They are not Registered “Investment” accounts. As such, the CRA has ruled in the past that high level of trading activity may be contrary to the intent of the account and therefore it is actual more of a business activity and assess taxation as though the transactions occurred in a regular investment account. Typically they focus on the TFSA because the funds are withdrawn tax free whereas all funds are taxed when withdrawn from an RRSP. An interesting but not well known feature of the TFSA is how withdrawals are treated. The withdrawn amount is added to the following year’s contribution limit (subject to a maximum annual amount). Unused contribution is carried forward. The Government of Canada source details this and the Royal Bank summarizes it nicely in addition to explaining over-contribution penalties.
A good tax strategy is as important as a good investment decision and together just may be a recipe for success. If a TFSA withdrawal is added to next year’s contribution limit and you are anticipating a bearish December but a return to a bull market leading up to legalization then is this not a strategy in itself because you can put the withdrawn money back into the TFSA in January (there are maximums regardless of your withdrawn amount).
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Until next time we continue to connect the dots so that you can invest long and prosper. Remember, there is no investment, legal, or tax advice being given or suggested in any form. Absolutely no wrong doing is being suggested of any person who is a paid stock promoter or analyst but rather to provide examples to subscribers of what may be perceived as a conflict of interest or a threat to impartiality.
See you in 2018 – the year when everything changes!
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