There are only a few approaches to making an RRSP withdrawal that make sense, and a “meltdown strategy” is not one of them

Registered retirement savings plans, or RRSPs, are a form of tax-deferred savings plan designed to help investors save for retirement. RRSP contributions are tax deductible, and the investments grow tax-free.

The best way to make an RRSP withdrawal is a popular topic. One of them, a “meltdown strategy,” is not as good as it appears.

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RRSP withdrawals as part of an RRSP meltdown strategy

An RRSP “meltdown” is a strategy some financial advisors suggest as a way to withdraw money from an RRSP while paying little or no income tax.

In the simplest form, you set up an investment loan and make the interest payments from RRSP withdrawals (an RRSP withdrawal must be equal to the interest payment). Since the interest on the loan is tax-deductible, the tax on the RRSP withdrawal is cancelled out. This, in theory, results in zero tax owing on your withdrawal.

You could use the investment loan to buy dividend-paying stocks, which provide you with income during retirement. Dividend-paying stocks also have the advantage of being very tax efficient.

However, RRSP meltdown arrangements often involve making RRSP withdrawals and placing the money in business or real estate deals—not dividend stocks—that generate large tax deductions. Those business or real estate deals then offset the taxable income from the withdrawals.

Investors who participate in this RRSP meltdown procedure are left holding an illiquid, and often quite risky investment. To generate the tax deductions, you may also have to take out or guarantee a large debt.

Sometimes the investment deal “guarantees” the RRSP meltdown investor a steady income. But the guarantee is very likely to be full of holes. The only things that are reliably guaranteed in these deals are the huge fees and commissions they generate for the salespeople and financial institutions involved.

We have looked at a number of these so-called RRSP meltdown deals over the years, and have yet to come across one that inspires our confidence.

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Consider an early RRSP withdrawal only in years of little or no income

Making early withdrawals from your RRSP only makes sense in a year of low income, which puts you in a low income-tax bracket, and you have exhausted all other sources of cash. That may happen in years when you are ill, say, or unemployed.

On the other hand, if you have cash to invest during a year of low income, a tax-free savings account (TFSA) is a good place for it. Like an RRSP, a TFSA is a tax shelter. But unlike RRSPs, contributions to a TFSA are not deductible, and withdrawals from TFSAs are not taxable.

Investing in a TFSA in low-income years will provide a real benefit in retirement. When you’re retired, you can exhaust your TFSA first, without paying any tax, and only then begin making taxable RRSP withdrawals.

There is no direct way to avoid paying taxes on an RRSP

There’s no direct way to take money out of an RRSP without paying taxes at the rate you would have to pay on ordinary income.

However, there are legal ways to lower your taxes on RRSP withdrawals.

You can make a contribution to a spousal RRSP. This way, when the money is withdrawn years later, it is taxed in the hands of your spouse, who may be in a lower tax bracket than you are. It’s also a good idea to plan things so that you use spousal RRSPs to split your retirement income between you and your spouse. This can lower the total tax burden on your retirement income as a couple.

Another way to lower the overall tax burden on your RRSP withdrawals is to make withdrawals in low-income years—even if you don’t need the money in those years. You’ll lose the tax-shelter on future earnings, of course. But you may reduce your taxes in the long run, particularly if you invest your RRSP withdrawals in stocks that you hold on to for many years.

It’s possible to use your own RRSP funds to make a mortgage loan on a home you are buying and gradually pay it back to your RRSP. But in light of the fees involved, it may be cheaper to get a mortgage from a conventional lender.

What has your experience been with RRSP meltdown strategies?

RRSP meltdown strategies are popular ways to attempt to reduce your tax liability on retirement income, but we believe there are other, better ways to accomplish the same goal. What is your preferred way to lower the taxes on your RRSP withdrawals?