The statistics are clear: most Canadians are not preparing for retirement. According to a new poll by CIBC, more than half of Canadians surveyed said they did not feel adequately prepared for this later stage of their lives.
It seems that people have a lot of reasons for not investing in an RRSP, which might account for why only about one-third of Canadians make an RRSP contribution each year. The problem is, many common opinions about RRSPs are myths that just don’t stand up to reason. Let’s look at the facts behind the flak…
1) Taxes, taxes and more taxes
One of the most common objections to RRSPs is that they are taxed. Well yes, but so is pretty much every cent you earn. But the way RRSPs are taxed is a little bit different – and that’s what makes them beneficial for the vast majority of people.
You see, RRSPs are tax-deferred. So let’s say you make $50,000 per year in 2011 and deposit $3,000 into your RRSP. At $50,000 per year, a taxpayer in Ontario will owe about $8,900 in taxes. However, thanks to contributing to your RRSP, that amount will be reduced to about $7,800 or a savings of $1,084 (which often means you’ll get that money back in the form of a tax return). Think of it this way: the tax you paid is essentially being returned to you for contributing to your RRSP. Better still, that $3,000 contribution won’t be taxed until you withdraw it many years later as income for retirement, giving it more power to grow into a bigger lump sum.
The real sweet deal: you are only taxed on this contribution once – when you take it out (and when you’ll likely be in a much lower tax bracket, meaning you get to keep more).
BONUS TIP: Reinvest that tax return. It’s like turbo-charging all of the above benefits! (I can help you with this)
2) Your tax rate
As previously mentioned, the general argument in favour of contributing to RRSPs and deferring paying tax on those funds is that many people will be in a lower tax bracket when they retire than they were during their working years. After all, if you are making $50,000 per year now, and you expect to retire at age 65, you will need to have more than $1 million dollars in your retirement fund to pay out that amount until you’re 90. For most people, that’s unlikely. This is why experts suggest your income will be lower during retirement. Of course, pensions and other retirement benefits count as part of your total income, so check with your tax professional to determine whether an RRSP is the best option for you.
3) The missing tax
When it comes to taxes, there’s one big thing that many of those who complain about the income tax on RRSPs are missing: RRSPs offer tax free growth on your investments. This benefit should not be ignored as an investor has the opportunity to avoid paying capital gains tax, and literally earn tax-free income within the plan for life. Therefore, regardless if you sell a winning stock, bank some interest on a GIC or earn a healthy dividend on your stocks, at the end of the year, you pay no tax.
So let’s say you have $5,000 that you want to invest. If you choose to leave it outside of an RRSP, you will first have to pay income tax. Then, if you realize a profit or earn income on that investment, you will be taxed on that as well – and that tax will be owed each and every year you crystallize a profit, earn a dividend or are paid interest thereafter.
In other words, tax can absolutely cut into the overall returns on your investment. But with an RRSP, you get to skip that tax altogether, allowing the funds to grow undisturbed and tax free as long as they remain within the plan. You will only pay tax on money when you withdraw it, leaving the remaining funds in the RRSP to continue to grow tax free. Holding on to more of your cash? That’s a huge benefit not to be dismissed.
There are exciting RRSP strategies which can earn you higher than average returns in a much safer environment. Contact me to find out.