With the recent volatility of the markets you may be wondering if any losses you have earned inside your RRSP, RRIF, or other deferred tax account can be used to reduce your overall tax burden. The short answer is no.
Any gains or losses earned inside an RRSP or other tax deferred accounts are accumulated inside the account free of any tax consequences. When the funds are placed in the account they are deducted from your income and when they are withdrawn the amount of the withdrawal is added to your income.
This was a question on of our visitors had asked recently and a brief exchange of e-mails uncovered an interesting scenario. Here is the exchange of e-mails:
Reader: I’m considering withdrawing funds from my RRSP to pay down my credit card debt. Can capital losses on investments within the RRSP be claimed to reduce the overall taxes that will be payable on the withdrawal?
Response: Unfortunately no. Any gains and losses inside an RRSP accrue without tax consequences. The withdrawal is added to your normal income.
Have you considered a consolidation loan?
Reader: We have tried consolidation loans in the past, but need to tap these savings to finance our children’s education.
Using an RRSP to Pay of a Child’s Education
Assuming the child is going to attend a post secondary institution and there was no RESP set up, does it make more sense to use the funds from an RRSP or have your child obtain a student loan?
Assume: Tuition and living expenses are $15,000, the child will live on campus, and is not expected to have a job during study. Further assume the parents are in a 45% marginal tax bracket, student loans will only cover 67% of the cost, and that the total education, textbook, and tuition tax credit is $1,960.
Withdraw from RRSP’s
If the intent is to pay the entire amount of tuition and living expenses the amount that would need to be withdrawn from the RRSP would need to be $27,273 in order to have $15,000 of after tax dollars available.
Obtain Student Loan and Contribute to an RRSP
The student loan would be $10,000 and the amount of the contribution to the RRSP is $5,000. The tax savings from the RRSP contribution would be $2,250 and the tuition, education, and textbook tax credit transferred from your child would be $1,960 for a total tax refund of $4,210. From which you would need to find an additional $790 to make up the entire $5,000.
Now your child will end up with $40,000 of student loans and you would end up contributing $20,000 to an RRSP. If you continue to contribute $5,000 to an RRSP you will receive $2,250 in tax refunds that you could provide as an annual gift to your child to help pay down the student loan (gifts are tax free to adult children). If the loan is to be re-paid at $811 per month over 5 years without the gift, the gift would reduce the term of the loan to only 4 years. Alternatively you could help offset the loan by $187.50 every month ($2,250 / 12). Further, the interest your child pays on the students loans will qualify as a tax credit to reduce their taxes and should be used to reduce the student loan debt.
The point is that when you withdraw from an RRSP, that contribution room is gone forever and can never be regained. By continuing to contribute, you are using funds that would have been otherwise used for tax to pay a portion of education.