With the declining prevalence of corporate pensions and the increase in Canadian personal tax rates, the importance of the RRSP and understanding how to properly use it continues to grow. The deadline to contribute to an RRSP for benefit in the 2019 tax year is Monday, March 2. The following are the principal benefits and considerations of making a contribution.

Retirement Planning

It is important to consider the outcomes of retirement savings and of using an RRSP. Creating a diversified source of incomes – registered savings such as an RRSP and RRIF, company pensions, government pensions, other savings, etc – is a critical component of effectively planning for retirement. Each of these income sources have differing tax implications, stability, and payment terms so it is important to build an integrated plan to ensure a consistent and potentially growing source of funds to pay lifestyle expenses and to fulfill retirement goals.

The RRSP is an effective savings vehicle or investment account and typically provides a significant portion of one’s income in retirement. The value of the asset, or account, and the resulting income it will produce should be determined. We now have tools to illustrate these outcomes in 5, 10 or 25 years based on some basic assumptions, and we can now build this income in to retirement plans to ensure goals can be met. While an enormous amount of attention is drawn to saving for retirement and taking advantage of an RRSP, without understanding what it will produce, it may be ineffective. The income may not be sufficient to meet retirement goals so alternate plans need to be considered. The total of all income may result in partial or full claw backs to Old Age Security. It may also be most effective to fund a spousal RRSP to allow for income to be split and overall improved overall tax savings in retirement. These are all important considerations in planning.

Taxes Saved Vs. Taxes Paid

Ideally, funds are contributed to an RRSP during peak or high earning years and then withdrawn during retirement and lower earning years. The result is attractive tax savings or even a tax refund for the contributions and minimal tax paid for withdrawals.

All RRSP’s (Registered Retirement Savings Plan) are required to be converted to RRIF’s (Registered Retirement Income Fund) before the end of the year in which the annuitant/account holder turns 71 years of age. The RRIF will begin to pay income according to a prescribed formula for minimum annual payments. This is essentially the Canada Revenue Agency collecting tax revenue by forcing taxable income to be paid from the RRIF. Taking advantage of this marginal tax rate arbitrage – high tax saved vs low tax paid – is one of the key benefits of the RRSP. An RRSP value that has been over-contributed to or has grown too high in value may reduce this benefit.

Sheltered Growth

The second main advantage to using an RRSP is the opportunity to shelter the growth in the account from taxes over an extended period of time. The principal of compounding growth is well documented. Earning a return on both the principal investment amount AND the return earned in prior periods is one of the foundations to long-term wealth creation. An RRSP allows investors to shelter these returns from taxes to allow more money to be compounding over time.

Using a $10,000 investment, with a fixed 5% interest return, a 50% marginal tax rate and a 10-year time period will produce the following values in an RRSP and a non-RRSP account:

                                              RRSP                                   Non-RRSP

                     Year 1              $10,500                                $10,250

                     Year 2              $11,025                                $10,506.25

                     Year 3              $11,576.25                           $10,768.91

                     Year 4              $12,155.06                           $11,038.13

                     Year 5              $12,762.81                           $11,314.08

                     Year 6              $13,400.95                           $11,596.93

                     Year 7              $14,071.00                           $11,886.85

                     Year 8              $14,774.55                           $12,184.02

                     Year 9              $15,513.28                           $12,488.62

                     Year 10            $16,288.94                           $12,800.84

From the above simple example, while both accounts benefit from the effect of compounding growth, the RRSP provides a significant advantage by compounding the full 5% annual return versus the compounding of 5% less 50% in tax owing for the non-RRSP account.

It is important to take advantage of the benefits of an RRSP, where possible, and to understand the long-term implications it has to you and to your retirement goals. If you have any questions or would like further information, you can contact me.