ON INVESTING

RRSPs: It ain’t necessarily so

Despite Canadians’ faith in the plans, new capital gains rules mean it may be better to invest outside

Deirdre McMurdy February 26 2001
ON INVESTING

RRSPs: It ain’t necessarily so

Despite Canadians’ faith in the plans, new capital gains rules mean it may be better to invest outside

Deirdre McMurdy February 26 2001

RRSPs: It ain’t necessarily so

ON INVESTING

Deirdre McMurdy

Despite Canadians’ faith in the plans, new capital gains rules mean it may be better to invest outside

There’s a good chance that right about now, you, like many Canadians, are scrambling to make your registered retirement savings plan contributions before the end-of-month deadline. Chances are equally good that you haven’t really questioned whether it’s the best way to save for your retirement. After all, the federal government encourages RRSP savj ings through a generous tax incentive program. Every bank, j credit union and trust company has extended its hours, strung i up banners and advertised aggressively to ensure they can help i you look after your future financial well-being. So there must j be something to it, right?

To pinch a phrase from George and Ira Gershwin, it ain’t nec: essarily so. There is a compelling argument to be made that,

i given recent changes in the capital gains tax structure, in many cases it makes more sense to borrow money to make equity inj vestments outside the shelter of RRSPs. j Perhaps the most ardent advocate of this iconoclastic notion

j is Talbot Stevens. A self-described financial educator and au; thor, Stevens argues that when you borrow to invest outside of

I an RRSP the interest expense is usually tax deductible and pro-

j duces the same tax savings as an RRSP contribution. The catch i is that RRSP dollars are taxable at rates as high as 51 per cent j when they are finally withdrawn. But when you borrow for eqi uity investments, much of your return is in the form of a capital gain, which is now effectively taxed at only half your norj mal rate. Under the latest mini-budget, just 50 per cent of a ; capital gain need be declared as income (down from 75 per cent

; a year ago). So if your normal tax rate is, say, 50 per cent, your

j net tax on the investment works out to only 25 per cent. And

j a tax-efficient mutual fund, adds Stevens, can produce almost j the same tax deferral benefit as the shelter of an RRSP “The I idea is to choose a strategy that produces the most net after-tax

j income,” he says. “But that’s not how things are pitched or fo! cused—everyone’s always looking at the figures before tax.”

Stevens is the first to admit his message hasn’t helped his ; business or his popularity in established financial circles, j “RRSPs are a sacred notion. And banks, insurance companies, i financial planners all have a vested interest in perpetuating—

: and marketing—that mystique,” he says. “The RRSP is a hot-

j button.” He adds that Canadians are reluctant to question I what they’ve always been told. “There’s always the inertia is-

sue and choice brings additional responsibility. People want things easy and pre-packaged,” he notes. “It’s just so much easier not to have to do the research and think and make big decisions—however important they are.”

Attesting to the momentum of mainstream thinking on the subject, a Gallup Canada survey released earlier this month by Investors Group of Winnipeg, the mutual fund giant, indicated that from 1990 to 1999, there was a 77-per-cent increase in the number of Canadians using registered investments. A full 61 per cent of Canadian adults participated in RRSP or RRIF savings plans and for those earning $50,000 a year or more, these vehicles represented at least half their total investments. However, a separate study released by the Toronto Dominion Bank at the same time revealed that most Canadians have a limited understanding of how much they need to save in order to retire. One in six believe that salting away just $100,000 in an RRSP is adequate.

Stevens finds these data maddening. “If you do the mathematical analysis, it’s not hard to conclude that conservative leverage outside an RRSP can make a big difference,” he says. “It’s just the herd-like behavioural aspect of this whole issue that’s frustrating.”

For example, Stevens says that most people automatically expect to spend the refund they receive as a result of their RRSP contribution, when they should, at the very least, be reinvesting that sum in the plan or “grossing-up” their contribution by borrowing a matching amount and paying that back with the refund proceeds. He also refutes the commonly espoused advice that one should limit RRSP loans to the amount that can be repaid within a year. That rule is “conventional but untrue,” he insists. “Longer-term borrowing can be a positive, forced saving commitment.”

Stevens is first to admit that he did not set out to rock the boat. In fact, he was in the same boat as most Canadians when he graduated from the University of Western Ontario in 1989 with degrees in mechanical engineering and computer science. “It didn’t take me long to realize that despite my fancy education, I was a financial illiterate,” he admits. “I realized that to survive, I needed to learn a lot more about how things worked and why.”

Having embarked on the process of self-education, Stevens found his interest sparked by the 1996 federal budget, which made changes to seniors’ benefits. And “after 18 months of mulling and math,” he began to challenge the universal wisdom of RRSPs. “I’m not anti-RRSP” he insists. “I just wanted to know if there was a better way to hold on to long-term savings.” There may well be a better way, but as another year’s deadline for RRSP contributions approaches, few Canadians appear ready to listen.