Insurance Understood: RRSPs are like carrots

By Steve Meldrum on February 1, 2020.

steve@swellwealth.com

Have you ever done something good so much that it actually created a negative outcome? Let me tell you about my little brother’s experience with carrots. He loved eating carrots and would eat them any chance he could. With a garden in the backyard he had unfettered access and approval from my parents to eat healthy vegetables. We would joke that he was part rabbit. Over a few weeks he had eaten so many carrots that he actually started turning orange and looking more like an Oompa Loompa from the movie “Charlie & the Chocolate Factory.” I have since learned that this happens because excess beta-carotene enters the blood stream and is stored under the skin. He learned a lesson about doing something seemingly good to an excessive level. This got me thinking RRSPs and how they compare to carrots and life insurance.

RRSPs are popular because you receive a tax deduction when you make a deposit into them. While the RRSPs remain invested you defer your tax, which allows the investment to grow faster. The common strategy is to deposit into RRSPs when you are earning a high income and then withdrawal from your RRSPs when you have a low income. The difference in the tax rate and the deferral of tax are to your advantage. However, when you redeem your RRSPs they are considered taxable. Let me explain how you can get to a point where you have too many RRSPs. Remember, RRSPs are taxable when redeemed, so if you are single or widowed with RRSPs the entire amount is considered redeemed in the year of death and added to your income. If you have a spouse or common law partner and pass away your RRSPs may roll over to them with no tax. However, when the survivor receives all of your RRSPs it may create even greater negative results if he/she cannot redeem all of the RRSPs tax efficiently before his/her death. Just like carrots, you can have a negative result when you have too much of a good thing.

Of course there are a couple fixes to this problem using life insurance. First, if you are single or widowed with significant RRSPs you may obtain life insurance to replace your wealth that will be lost due to taxes. It is worth noting that since 100% of your RRSPs will be added to your income in the year of death your tax rate may increase. I encourage you to actually calculate the tax bill on death due to RRSPs. My firm does integrated planning with investment and insurance and I know it is a balance to get the right mix. This provide peace of mind to what your loved ones or estate will ultimately receive.

Secondly, you can use life insurance as an investment tool. I feel that it is one of the hidden gems of investing. With a permanent insurance policy you can make deposits into it above the actual cost. Those deposits are invested and grow tax sheltered like an RRSP or TFSA does. The big advantage at death is that there are no taxes triggered. I should mention that probate is also avoided, which is a perk. Life insurance is a proactive way to mitigate your final tax bill, increase your wealth and avoid having too much of a good thing. Don’t get me wrong, I love RRSPs and carrots, there just need to be a proper balance and thoughtfulness into the accumulation and withdrawal of them.

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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