The cashless RRSP contribution

When the federal government announced a few years ago that old issues of compound interest Canada Savings Bonds could be contributed to a special RRSP, it awakened many people to the fact that you don’t need cash to generate a tax deduction.

In reality, there was nothing groundbreaking about the announcement. CSBs have always been eligible for inclusion in an RRSP or RRIF. But in the past, you needed a self-directed plan to hold them, which few people had. All Ottawa did was make it easier.

Depositing old issues of Canada Savings Bonds into an RRSP is an excellent strategy, for two reasons. It allows you to obtain a tax deduction without dipping into cash reserves. Plus, it shelters future CSB interest from tax. The process is technically known as a “contribution in kind.”

Contributions in kind are not limited to CSBs. Any qualified security can be put directly into an RRSP, within the usual contribution limits, and receive full credit for a tax deduction at the security’s current market value. This strategy can be extremely valuable if you’re short of cash at RRSP time. However, apart from the special government CSB program, contributions in kind arenly possible with a self-directed plan.

For example, suppose you have $5,000 invested in a GIC that doesn’t mature for three years. You can’t cash it in, but you’re short of money for this year’s RRSP contribution. If you have a self-directed plan, you can simply contribute the GIC to it. You’ll receive credit both for the principal amount and all compound interest earned up to that time. If the interest rate is 5 percent and you’ve held the certificate for two years, you’ll actually receive credit for $5,512.50 when you make the contribution. Make sure you don’t end up overcontributing to your RRSP by failing to take your accrued interest into account.

Here’s another example. Suppose you have mutual fund units that have done well. You haven’t held them the requisite seven years for the deferred sales charge to run down to zero, so you don’t want to sell them just yet—but you need money for this year’s RRSP contribution. As an alternative, you could contribute the units directly to the self-administered plan. The amount of your contribution will be based on the market value of the units on the day they go into your RRSP.

There are tax implications you should be aware of, however. Any time you make a contribution in kind to an RRSP, the Canada Customs and Revenue Agency takes the position that you’ve sold the security— “disposed of it at fair market value” is the technical phrase.

If the asset has increased in value since you acquired it, you’ll have a capital gain. For example, if you bought the mutual fund units for $5,000 and they have a market value of $7,000 when you put them into an RRSP, the government will take the position that you have a capital gain of $2,000. You must declare the income on your income tax return and pay the appropriate tax.

You can’t get around this by selling the security first and then buying it back inside the RRSP. You’d actually end up worse off because you’d still have to declare a capital gain, plus you’ll have to pay the commission that’s triggered when you sell it and possibly when you buy it back. Nor is it a good idea to use this approach with securities that have declined in value. That’s because, while the Canada Customs and Revenue Agency decrees that any capital gain you make in this situation is taxable, it won’t allow you to claim a capital loss. In this case, you’re better off selling the security and using the cash from the sale for your RRSP contribution. That way you’ll be able to claim the loss on your tax return, as long as it can be offset against other capital gains.

These rules won’t apply to securities such as Canada Savings Bonds and guaranteed investment certificates because their value is fixed—they usually have no potential for capital gains or losses (there are exceptions in the case of some GICs). Any increase in their value is normally related to compound interest and is taxed accordingly. Obviously, you’ll have to declare any interest earned on your CSBs and GICs up to the time they went into your retirement plan.

So, to summarize, here are the rules for RRSP contributions in kind:

1. You must have a self-directed RRSP to make contributions in kind, except in the case of CSBs where you can use the special, no-fee government program.

2. The security must be a qualified investment.

3. The security must be contributed at fair market value.

4. Any accrued interest will form part of the contribution.

5. A contribution in kind will produce a tax deduction in the same way as a cash contribution.

6. The total value of the securities, including accrued interest, may not exceed your normal RRSP contribution limit.

7. Contributing a security that has increased in value since you acquired it will trigger a capital gain that must be declared on your income tax return.

8. You should not contribute a security that has decreased in value since being acquired, as this will result in a non-claimable capital loss.

From Gordon Pape’s 2001 Buyer’s Guide to RRSPs, published by Prentice Hall Canada.