The Truth about RSPs
If what you KNEW to be true about RSPs was not true, when would you want to know?
What is the number one reason Canadians contribute to an RSP? It’s not to save for retirement. It’s to LOWER THEIR TAXES THIS YEAR. But this approach can often be a big mistake. Your goal should be to save taxes over your lifetime … not just this year.
I hate to say this, but advisors and financial institutions can be biased because of how fees and commissions are paid. For example, if you contribute $20,000 to an RSP and you are in a 30% tax bracket you will get a refund of $6,000. So your out of pocket investment is $14,000. As an alternative, you could have invested $14,000 to a non-registered plan or TFSA. Here’s where the bias can occur. What do you think would be the preference of planners or financial institutions? Commission on $20,000 or commission on $14,000?
Tax rates now and in the future plan an important role in whether or not it makes sense to contribute to an RSP. Let’s look at an example.
- You save $20,000 every year in an RRSP
- You are in a 40% marginal tax bracket
- You get a refund of $20,000 x 40% or $8,000
- Your net savings is $12,000 every year
- You do this for 20 years
- You earn a steady 8% rate of return
- Your RSP is worth $915,239 in 20 years
- This gives you an income of $93,219 for the next 20 years
- You are in a 40% tax bracket
- Your net income is $93,219 x 60% or $55,931 per year
- You save $12,000 every year in a tax free environment
- You still earn a steady 8% rate of return
- You do this for 20 years
- Your saving is worth $549,143 in 20 years
- This can provide you an income of $55,931 per year
Gosh … when you look at the above numbers … it all seems like a bit of a shell game where the financial intermediaries are always the winners.
RSP CONTRIBUTIONS ONLY MAKE SENSE IF YOU WILL BE IN A LOWER TAX BRACKET IN RETIREMENT
YOU SHOULD BE CONSIDERING STRATEGIES AS ALTERNATIVES OR COMPLEMENTS TO YOUR RSP SAVINGS
- Tax Free Savings Accounts – Would it make sense to consider investing in a tax paid up investment pool of funds that will help to lower your taxable income in retirement and avoid the claw back of government benefits like OAS or GST?
- Paying down debt – If you have high interest debt, or are not able to pay off your credit card bills every month, your RSP contributions are contributing to your debt problems as well as affecting your credit score and overall wealth
- Rental property purchases – Have you considered instead of contributing to an RSP, purchasing a rental property that can provide you with a tax advantaged income now as well as in retirement without the volatility of stock markets?
- Permanent insurance – What if instead of the “cost” of term insurance, you “invested” in permanent insurance that can provide you with a tax free retirement income.
TAX TIP: SAVE YOUR RSP CONTRIBUTION ROOM FOR A VERY HIGH INCOME YEAR EG) WHEN YOU SELL AN INVESTMENT OR INVESTMENT PROPERTY AND HAVE A LARGE CAPITAL GAIN TO SHELTER.
So now that you know the truth about RSP savings, what are you going to do about it?