RRSP dividend reinvestment strategies

By Bruce Sellery on November 16, 2012
Estimated reading time: 4 minutes

Losing money in your RRSP isn't a good reason to wind it up, says Bruce Sellery.

Question

When the market tanked a few years ago I couldn’t stand the losses in my RRSP so I cashed it out, paid the taxes, and invested the rest in 15 different stocks, all in DRIPs (Dividend Reinvestment Plans). I’ve had about a 32% return so far. My wife still has an RRSP, but because of illness she has not added a dime to it over the past few years. Her mutual funds have had no increase to speak of. Is there a way she can cash out her RRSP, but without having to pay the taxes?

Answer

Yes and no. I’ll explain in a minute. But only if you promise to read about the giant red flag that your strategy entails. You’ll find it at the end of this post. Do you promise?

Okay, good.

First, yes. If you sell down her mutual funds and buy the same 15 dividend stocks you own and—this is important—keep them within her RRSP she’ll avoid the taxes. But the automatic dividend reinvestment part of the DRIP that you are fond of may not be available within the RRSP. Her RRSP is almost certainly held by a third party and chances are that institution won’t make frequent, small stock purchases very easy. You may have to pay a commission each time and buy whole shares, unless your broker offers a synthetic DRIP on the companies you want to invest in.

Synthetic DRIPs

Most brokerages now offer synthetic DRIPs. If you were to buy a dividend-paying stock or ETF that is on the brokerage’s eligible list, the firm would buy additional shares of the stocks as the dividends accrue. They only allow whole shares, however, and you may be hit with fees—two important drawbacks compared to traditional DRIPs offered by the companies themselves.

You could also set her up in a regular DRIP and ask for a share certificate, which you would then transfer “in kind” to her RRSP. This is a more complicated option, and involves the calculation of your adjusted cost base for capital gains tax purposes. This would definitely be too much work for me.

Call your discount brokerage and find out how their synthetic DRIP program works and if the 15 stocks you want to hold are on their list.

Cashing out RRSP wasn’t necessary

The good news is that you can figure this out for your wife. The bad news is that you didn’t have to sell out of your RRSP.

You were in good company in 2008. A lot of investors felt overwhelmed by the massive declines in the stock market and took drastic measures. But remember that an RRSP is just a cupboard—a special cupboard that allows you to defer income tax. You could have sold all your investments and bought those 15 stocks inside the cupboard without paying those taxes. True, the logistics of the DRIP strategy would have been more complex, but even if you just bought the same dividend stocks and invested the dividends manually, instead of through a DRIP, you would have come out ahead.

This time around, with your wife’s RRSP, you can set her up on a synthetic DRIP or simply sell the mutual funds she currently has and buy the 15 dividend stocks that you own. Then, as per my point above, invest the dividends those stocks spin off in additional shares.

Waving a giant red flag

You didn’t mention your respective ages, but I’m guessing you aren’t in your mid-20s. Let’s say you are both 60. The rule of thumb for someone that age is that you would hold 60% of your portfolio in fixed income—say bonds, bond ETFs or bond funds. You didn’t mention anything about other assets, other income, or a company pension, so I assume that your RRSP is what you’re going draw on for grocery money in retirement.

Here is the red flag: If you have 100% of your portfolio in just fifteen stocks, even dividend paying stocks, you’re taking a lot of risk. Those stocks could fall dramatically in value, or the dividends could be slashed. To put your wife into a similar portfolio doubles your exposure to the stock market thereby increasing your risk even more.

The dividend strategy can work. But please use it in the equity portion of your asset allocation and not across the board. Click here for some thoughts on the “Safest way to save for retirement”.