With Tom Brady playing another Super Bowl final, his groundhog-like appearances in February now mean one thing to Canadians: we’ve just passed the halfway point in ‘RRSP season’.
This is the time of year Americans celebrate football, and Canadians calculate finances. RRSP season, lasting for the first 60 days of the year, is when we’re encouraged to max our RRSP contributions to their annual limit, allowing us to claim the associated tax deduction on our 2017 tax returns.
But more and more Canadians are experiencing the chills of RRSP season, as more people question whether RRSPs are still a viable way to save for retirement.
The short answer? Absolutely they are. We’ll clear three of the most common RRSP myths we regularly hear, and why they shouldn’t stop you from saving for your future.
Anything I save, I’m just paying back in taxes when I retire anyway.
We’ll start with a very popular RRSP ‘fact’ that’s simply incorrect.
Now, while it’s true you do pay tax on RRSP withdrawals, remember you also get a tax deduction on contribution.
So, if your tax rate remains the same during the year of contribution as it is in the year of withdrawal, your RRSP is essentially giving you a tax-free rate of return on your contributions. And in most cases, even if your tax rate is higher in the year of withdrawal, you’ll get an even more lucrative after-tax rate of return on RRSP investments.
Why is an RRSP better than a non-registered, investment alternative? Easy – long-term compounding that’s essentially less tax-free.
Let’s break it down: Ned earns $80,000 annually, and contributes $3,000 of that income to his RRSP. His marginal tax rate is, let’s say, 33.33%, and he should be in the same tax bracket when he withdraws his RRSP funds.
If that investment fund grows by 5% after the first year, it’ll be worth $3,150. Cashing in that RRSP would net a total $2,100, or $3,150 minus the 33.33%.
Now, if Ned avoids the RRSP route and puts his employment savings in a non-registered account, with the same investment rate of return, he’ll lose out.
In this scenario, he’d need to pay a $1,000 tax ($3,000 x 33.33%) on employment income BEFORE investing the $2,000 net income in the non-registered account. That same 5% growth would boost his investment value by $100 ($2,000 x 5%).
Cashing in at the end of the year, Alex would need to pay tax totaling $17 ($100 gain x 33.33% x 50% taxable capital gain), resulting in a net total of just $2,083.
While that number seems insignificant – it’s just $17, right? – remember that those savings scale with better investments, and more money put in an RRSP. Plus, it’s evidence of the viability of long-term compound saving via RRSPs.
RRSP? Pffft. TFSA is my investment acronym of choice.
With TFSAs being completely tax-free, many Canadians believe this is the investment horse to bet on.
But the rule of the thumb is that an RRSP is the superior choice in most cases if you’re expecting a lower tax rate when you retire. A TFSA may be the better option for those that foresee a higher tax rate on withdrawal, or facing repayment of government benefits.
Having said that, a TFSA by itself may not leave you enough room to save enough; contribution limits are just $5,500 a year. An RRSP would likely be needed anyway to support any TFSA retirement savings.
I just don’t have the money to put aside in an RRSP.
This is all wrong – if you don’t have enough money, make sure that’s not a problem in the future…and start putting money in that RRSP!
Even the most modest of contributions can pay big dividends down the road (long-term compounding will be your favourite three words).
Say you can only put aside $100 a month in your RRSP from ages 30 to 65, with a long-term, 5% rate of return on investments.
In those 35 years, that would amass to $114,000 in your RRSP, ready for retirement. And your savings could add $9,100 of pre-tax income annually for the next two decades, ON TOP of any retirement income.
If you don’t think you’re responsible to put aside $100 a month, there’s no excuse for that either – setting up an automatic savings plan is simple. Your employer may even offer this convenience, with some matching an employer’s contributions for double value!
Your finance priorities should be paying off high-interest debt, and then worrying about saving for retirement.
Make the most of RRSP season and get as close to your max contribution before the end of February! Trust us, your future self will thank…uh, yourself.
If you want to really save for the future, but it’ll tighten up funds for the next couple months, we offer short-term loans that cover any expenses as you build towards your future. This next month is crucial to your retirement!