I recall a conversation I once had with my grandfather about money. "Tim," he said, "ready money is Aladdin's lamp." He was always big on having money available to seize opportunities when they came up. Many Canadians are the same way. The problem? Many people have been eyeing the money in their registered retirement savings plans (RRSPs) as a solution for their short-term cash needs.
Withdrawing money from an RRSP is not the big problem -- although there are definite drawbacks to dipping into your retirement savings early. The problem is that too many Canadians have tried to get money out of their RRSPs without paying any tax at all. And many of these people have fallen prey to elaborate RRSP schemes being promoted by unscrupulous individuals who are trying to make a fast buck.
These schemes often start with advertisements making claims such as "Take advantage of your RRSP now -- no tax to pay!!," or "I will loan you $5,000 to $250,000 over five years if your RRSP is locked in."
The Canada Revenue Agency (CRA) recently issued a warning about promoters of financial schemes that promise RRSP owners tax-free withdrawals from their plans. These arrangements typically involve using a self-directed RRSP to buy the shares of a private company, or an interest in mortgages. The funds that are advanced by the RRSP are then loaned back to the owner of the RRSP -- but only after exorbitant fees.
In some cases, private company shares and mortgages can be eligible investments for an RRSP. But the criteria that must be met for these things to qualify is such that what is typically offered under these schemes won't cut it. That's a real problem. Why? If an RRSP acquires private company shares or other assets that are not a "qualified investment" under the Income Tax Act, the full value of the shares or assets may be added to your taxable income. Ouch.
But it gets worse. These schemes typically work so that your RRSP is pledged as collateral for the loan made to you. Bad idea. If an RRSP is used as security for a loan, the value of the RRSP is added to your taxable income. Ouch again.
In a 2004 court decision Dubuc v. The Queen, the taxpayer learned the hard way that getting involved in a scheme that doesn't work under the tax law will not allow you to escape the tax consequences, even if you, in good faith, trusted a promoter who seemed professional and on the up-and-up.
In this case, Ms. Dubuc purchased shares in a private company using RRSP dollars totalling $20,000. Then, a company related to the private company made a loan of $16,620 to Ms. Dubuc, less fees of more than $3,000. The loan was secured by her RRSP. The judge didn't question her good faith, but went on to say: "Although the appellant is sympathetic and although she may possibly have been the innocent victim of an actual professional swindle, the appeal must be dismissed because the assessment is correct."
In other words, as sympathetic as the court might be, the judge has to rule in accordance with the Income Tax Act. So buyer beware. The bottom line? If an idea involves getting money out of your RRSP tax free, and it sounds too good to be true, it probably is. At a minimum, speak to a tax professional about a scheme you're contemplating to get the real goods on the strategy.
Tim Cestnick, FCA, CPA, CFP, TEP, is a tax specialist and author of Winning the Tax Game 2005 and The Tax Freedom Zone.
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