Insurance Understood: Ice cream and RRSPs

By Medicine Hat News on January 12, 2019.

Once as a teenager, my older brother and I were at a grocery store when there was a sale on two-litre cartons of ice cream. The store had my favourite kind, cookies and cream. My brother told me that if I could eat the entire two litres carton he would pay for it but if not then I would have to pay him back double the cost of the ice cream.

I was confident I could eat it all so he bought it for me. I proceeded to smile as I ate the ice cream. However, as I got near the end I was not as enthusiastic and it became difficult to eat my favourite ice cream. It became unpleasant to have so much ice cream and even made me a bit sick. Unfortunately, I could not complete the carton. Therefore, I lost out on our wager and I had to pay my brother more than the original cost of the ice cream.

This reminds me of how RRSPs can be when we have too much of them. Indeed there can be too much of a good thing.

The idea of an RRSP is to make a contribution to an investment and the government will provide you with a tax deduction for that amount. The savings are based on your marginal tax bracket. Thus more income you have the greater the benefit to purchasing an RRSP.

However, you do eventually have to pay taxes when you redeem the RRSP. The goal is to put money into an RRSP when you are in a high marginal tax rate and to redeem it when you are in a lower marginal tax rate. If this is the case then the difference of marginal rates will increase the overall return of the investment strategy. Unfortunately, just like my ice cream experience, there can be a snag in RRSP planning. When you pass away and don’t have a surviving spouse, common law partner or dependant child then all of your RRSPs become taxable in the year of death. Yes, 100 per cent of your RRSPs will get added to your income and therefore increase your marginal tax. I commonly do stress testing of portfolios and realize that the individual can actually go backwards by continuing to put money into a RRSP. That is because they would be putting the money in at a lower tax rate than when they pass away and their estate is forced to pay a higher tax rate as the full RRSP is added to the income in the year of death.

What is a solution? One simple strategy is to put life insurance in place to counter or pay the tax bill. Indeed the insurance can protect your investment portfolio and not just your income. Although the taxes will still be paid the insurance can restore the portfolio back to its position or even enhance the portfolio. The best part is that it is at a lower cost than doing nothing and simply paying the taxes. Although it is a great feeling to have a lot of RRSPs, I encourage you to do a stress test of your estate plan and make sure that you don’t end up paying more in taxes by having too many RRSPs.

Steve Meldrum B.Mgt. CFP CLU is the founder of Swell Private Wealth Ltd. For over a decade he has specialized in helping individuals and businesses expand protect and perpetuate their wealth. For further information or tailored advice, contact him at 403-487-0490, steve@swellwealth.com or connect on social media.

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