Andrew Dunn of Deloitte Canada has some ideas quoted at the Wealthy Boomer on changing the way RRIF withdrawals are taxed. On the surface these ideas seem to make a lot of sense, but on analysis, the reasoning breaks down.
As things stand now, when you pull money out of an RRSP or RRIF, the amount gets included in your income for the year. Over the years this tax-sheltered money grows through capital gains, dividends, and interest, but none of that matters when filing your taxes; all withdrawals become regular income that is taxed at your top rate.
Dunn suggests that the type of returns should be tracked so that when you withdraw the money, it gets taxed as capital gains, dividends, and interest so that some of it will be taxed at lower rates.
This seems reasonable at first, but it ignores the real nature of RRSPs. An RRSP is a vehicle for deferring taxes. Your contributions are untaxed in the year you make them and get taxed when you withdraw them.
Let's consider an example to illustrate why the current system makes sense. Sally opened a new RRSP with a $10,000 contribution. Her marginal tax rate is 40%. If she hadn't made the RRSP contribution, she would have kept $6000 and paid $4000 in additional income taxes.
Sally should think of the $10,000 sitting in her RRSP as being $6000 for her and $4000 for the government. In this sense, $6000 in a TFSA has about the same value to Sally as $10,000 in an RRSP (assuming her tax rate is also 40% when she pulls money out of the RRSP).
Fast-forward 25 years. Sally's $10,000 has grown to $100,000, and her marginal tax rate is still 40%. This money is still only 60% hers. The whole amount grew by a factor of 10, and her portion grew by a factor of 10 from $6000 to $60,000.
If we focus on Sally's portion, it has grown completely tax-free. The growth of the government's portion will cover the taxes owing. So she will get all of her portion over time without having to pay any additional taxes on its growth.
Any further tax breaks Sally might get along the lines of Dunn's proposal are outside the intent of RRSPs. Additionally, the complexity of tracking the nature of all the gains would be a burden.
If the government wants to give additional tax breaks to people making withdrawals from RRSPs and RRIFs, something simple like making the first $3000 withdrawn each year tax-free is preferable to Dunn's proposal that would require significant accounting information to be retained for decades.