Investing Inside an RRSP vs. Outside an RRSP

There were a couple of blog articles recently about investing inside an RRSP vs. investing outside an RRSP. Frugal Focus discusses a report by Phillips, Hagar & North called “The Retirement Savings Debate: Inside or outside the RRSP structure.” He makes note of the fact that

the publication of this report preceeds two potentially important events – the November 2005 announcment by the former Liberal government regarding changes to taxation for dividend income and the yet-unrealized election promise by the new Conservative government to allow capital gains to be eliminated for individuals on the sale of assets when the proceeds are reinvested within six months

The Canadian Capitalist orginally blogged about this and focused on an article by Derek Foster (author of “Stop Working”) in Canadian MoneySaver magazine that discussed ways of investing outside your RRSP. Foster has some interesting ideas, like this one:

Suppose you were planning to put $6,000/year into an RRSP to save for your retirement. You would be contributing to your RRSP and getting a portion of that back because you could use the RRSP contribution as a deduction. Thus, your out-of-pocket annual expense would be $6,000, less the amount of tax money you have refunded.

Another method of achieving the same result is to take out a secured line of credit (let’s say $100,000 @6%) and invest it in good quality, blue chip, dividend-paying equities. Now you’ll be paying the $6,000 towards interest instead of putting it into an RRSP, but you will still get the same deduction as your out-of-pocket expenses are exactly the same! Money borrowed to invest is tax deductible. The only difference is that now you have $100,000 invested in a non-registered account that holds dividend-paying stocks rather than a contribution of $6,000 every year in your RRSP. You get the benefit of the dividend tax credit, while still getting a full deduction on the $6,000 interest payment (exactly the same effect as contributing to an RRSP).

The Canadian Capitalist has a good argument for why leveraging may not work. The Phillips, Hager & North report mentions leveraging as one of the purported advantages of investing outside of an RRSP, although they mention that “borrowing money to invest in a non-registered accoutn has risks that are not addressed. . . ”

I strongly recommend reading the Phillips, Hager & North article. It is only 7 pages of easy-to-read material. Here is the conclusion though, for those with little time on their hands:

Our analysis shows that saving for retirement using a registered plan (RRSP) is more beneficial than saving in a non-registered, taxable account. There are a few exceptions to this, but for the most part, this conclusion will hold true for the majority of middle- and upperincome earners.