Is it worth investing in an RRSP? Here’s the math

Posted on by Duane Roberts

Personal Finance

RRSP contributions can significantly lower your total taxable income in the tax year and increase your retirement savings

Publication date:

February 17, 2022 • February 17, 2022 • 3 minute read • 6 Responses Investment portfolios grow tax-free as they are invested within the RRSP, and the rate-increasing effect becomes even greater over a longer time horizon. Investment portfolios grow tax-free as they are invested within the RRSP, and the rate-increasing effect becomes even greater over a longer time horizon. Photo by Brent Lewin/Bloomberg

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This is always an exciting time of year for financial geeks like me or those who get excited about things like updating spreadsheets. You see, I’m a fan of Registered Retirement Savings Plans (RRSPs), Tax-Free Savings Accounts (TFSAs), and all the other tax-deferred, tax-protected vehicles because one of the certain things in financial planning is that taxes inevitably trend up over time.

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Even though we live in a country with relatively high income taxes, contributing to an RRSP can still be a controversial topic, and from time to time I’ve heard people question the merits of an RRSP. Here are some of their main objections:

Since not all gains in the investment portfolio are fully taxable, such as capital gains, does it make sense to put money into an RRSP so that all withdrawals are fully taxed as regular income?

When you retire, it can be heartbreaking to see some of your hard-earned retirement income go down with a withholding tax.

But consider this:

RRSP contributions can significantly lower your total taxable income in the tax return year and improve your retirement savings;

Investment portfolios grow tax-free as they are invested within the RRSP, and the rate-increasing effect becomes even greater over a longer time horizon;

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The difference between current and future tax brackets matters. With proper planning, total taxable income at retirement should be less than your peak income years;

And having a diversified set of income streams to draw from in retirement can maximize flexibility and tax efficiency.

No

FP Answers: Can I retire on $48,000 a year at age 43?

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Canada Pension Plan can start as early as age 60 or be deferred until age 70.

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Although you must claim an RRSP contribution in the year it is made, you can carry over the deduction to use in a future year.

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Let’s look at a numerical example of investing in RRSPs versus an unregistered account. We’ll keep the assumptions simple. The investment has an annual return of six percent in interest income, and you have a marginal tax rate of 40 percent each year.

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Since contributions to your RRSP are actually made with pre-tax dollars and contributions to your unrecorded account are made with after-tax dollars, we also assume that you have $10,000 to invest in your RRSP and $6,000 ($ 10,000 x 60 percent) after-tax funds to invest in your unregistered account.

Finally, for a simplified, but complete, after-tax net rate comparison, the example assumes you withdraw the full amount of your RRSP and pay tax at your marginal tax rate of 40 percent on the 10, 20, and 30 year marks.

We have kept the assumptions conservative, but the accompanying table shows that we were still able to demonstrate a net benefit from investing in an RRSP.

convinced? Here are three helpful tips to help you get the most out of your RRSPs.

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You can contribute as early as the first day of the year and claim your contribution when you’re ready to file your tax return.

RRSP contributions are used to reduce your total taxable income for the year. An abbreviation for calculating your tax refund is to multiply the approximate dollar amount contributed by your marginal tax rate.

You can borrow to contribute to your RRSP, but whether you really need to do so depends on your tax bracket and individual situation. Given today’s low interest rates, borrowing to invest can be beneficial, but leverage should be used with caution and only after careful consideration of your financial situation and overall financial plan.

Have fun saving and investing.

Rita Li is an investment advisor at RBC Dominion Securities, RBC Asset Management†

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This post Is it worth investing in an RRSP? Here’s the math

was original published at “https://financialpost.com/personal-finance/does-it-pay-to-invest-in-an-rrsp-heres-the-math”

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