Financial Advice: Should I Invest in RRSPs?
Should I Invest in RRSPs?
Should I Invest In RRSPs?
It has been ingrained into most people that you should invest in RRSPs. Start as soon as you can and max it out every year. But will this provide the best financial results? Is this for everyone? What is an RRSP? We are here to answer those questions.
What is an RRSP?
An RRSP or Registered Retirement Savings Plan is an investment structure created by the Canadian Government to help Canadians save for retirement. While it is referred to as a “retirement” account an RRSP is designed with the purpose of saving during your income-earning years for your non-income earning years. Once inside this structure, you can invest the funds however you would like Stocks, Bonds, Mutual Funds, ETFs, GICs, Cash, etc. are all available to you. You also can have multiple RRSPs or different varieties of those investments inside your RRSPs. With an RRSP, you have a lot of control; the only restraints may be the broker, bank, or investment body you choose to invest with.
Advantages of an RRSP
Investments inside an RRSP are tax-deferred - The main feature of an RRSP is tax-deferral. Once funds are inside you do not have to pay tax on interest, dividends, or capital gains. This will allow investments to grow faster than outside of an RRSP.
Contributions are a Tax Deduction - To incentivize savings, the government allows contributions into an RRSP to be deducted from your income. This helps reduce the amount of tax you pay on your income in those years.
Options for Tax-Free Withdrawals - While regular withdrawals are taxed, there are a couple of reasons you may withdraw from an RRSP without paying tax. One of those reasons would be for the Home Buyer’s Plan or HBP, which is up to $35,000 to purchase a home. Another reason is for the Life Long Learning or LLP, which is up to $20,000 to pay for post-secondary education.
Disadvantages of an RRSP
Withdrawals are Taxed - You will be able to grow money quickly and get a tax deduction when you contribute but when you withdraw the funds you will have to pay income tax at your current rate.
Withdrawals are Always Income - While there are more tax-efficient ways to earn money dividends or capital gains, no matter how you earn an income inside an RRSP all withdrawals will be taxed as income.
Withdrawals add to your Income - Withdrawals will be added to your income this may push your income into a higher tax bracket if you take out too much. Therefore, RRSPs must be withdrawn over years as opposed to large lump sums.
Contributions
Every Canadian has a contribution limit of how much they can put into their RRSP, whether you have 1 or 10, your combined limit remains the same. If you do not use your RRSP contribution room that will be carried over into future years. Every year you earn an income your contribution limit will grow, this amount is 18% of that year’s income up to a maximum of $30,780 (2023 maximum).
When you make an RRSP contribution the amount that you will contribute will become an income tax deduction. Because we are in a marginal tax system in Canada, making an RRSP contribution may lower the percentage of your income you pay in tax.
Example:
In 2023, for every dollar you earn over $111,733, you will need to pay 43.41% to tax. This is a larger jump from the 37.91% tax on money earned below $111,733. If you made $120,000 in income for 2023, you could contribute $8,267 to avoid paying 43.41% tax on that amount.
Withdrawals
On the other end of the spectrum, RRSP withdrawals are added to your income tax for the year. Ideally, the thought would be you are going to pull money out of your RRSPs when you are in your lower-income earning years (Retirement, Out of work, etc.). Therefore, you are paying less taxes to the government.
Example:
Using the Example above, if you contributed $8,267 into an RRSP in 2023, you avoided paying the 43.41% tax. If your income was $30,000 in 2024, you could pull out the $8,267 and add that to your income. This would bring your income to $38,267 and at that level, you would pay 20.05% tax. By using an RRSP you saved about 23% or about $1,900 in taxes.
This would be outside pulling funds out for the Home Buyer’s Plan or Life Long Learning Plan discussed earlier.
For more information on those withdrawals please visit the CRA website:
Choosing Your Tax Dates
One of the biggest advantages of an RRSP is choosing when you are taxed. Through contributions, you have the ability to be taxed less in higher-income years, and through withdrawals, you have the ability to pull funds out in lower-income earning years.
This can be a great tool for anyone, especially if they have fluctuating incomes.
Comparison vs. Non-Registered
The other large advantage would be tax-free growth until later in life. We can see how this affects the growth of your investments.
Example
Contribution: $10,000
Individuals Tax Rate: 30%
Investment: 4% GIC
Time Period: 20 Years
Inside an RRSP
Deposit $10,000 into an RRSP and receive back $3,000 in a tax refund through your contribution deduction
Invest the $10,000 into a GIC at 4%
Invest the $3,000 outside the RRSP in a GIC earning 4% (you will lose 1.2% of this return to taxes)
After 20 years you will have:
$21,911 in your RRSP
$5,212 outside of your RRSP
If you pull the entire amount of the RRSP out at 30%, you would be left with $15,337 after taxes and the other $5,212 from the tax refund you invested 20 years ago.
The total amount you would have would be $20,549.
Outside an RRSP
Invest the $10,000 outside the RRSP into a GIC at 4% (you will lose 1.2% of this return to taxes)
After 20 years you will have:
$17,372 outside of an RRSP
The total amount you would have would be $17,372.
In this example, the value of tax-free growth did make a significant difference in the amount of after-tax dollars to the individual.
Should You Invest in RRSPs?
Yes, but maybe not always. RRSPs are a great vehicle for saving your lower income-earnings years, but they are not for everyone. They have large advantages when used properly but if you are already in your low-income-earning years withdrawing from your RRSP in higher-income-earnings years would be a disadvantage. An RRSP is a powerful tool in your toolbox, speak with a financial advisor or tax professional to see if they are right for your situation.
Justin, Konrad, and Merriel
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Content Sources: Bloomberg, Trading Economics, Yahoo Finance, BCA Research
Disclaimer: This newsletter is solely the work of Konrad Kopacz and Justin Lim for the private information of their clients. Although the author is a registered Investment Advisor with Echelon Wealth Partners Inc. (“Echelon”) this is not an official publication of Echelon, and the author is not an Echelon research analyst. The views (including any recommendations) expressed in this newsletter are those of the author alone, and they have not been approved by, and are not necessarily those of, Echelon.
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