For the rest of the month, you will be bombarded with ads for RRSP investments. But is the RRSP the right vehicle for you to invest in?
Disclaimer: This is a very generalized article. The basis of it probably applies to your situation, but the details may not. And while I am a financial advisor, I am not YOUR advisor (unless, of course, we do have the advisor-client relationship). You should talk to your (an) advisor before taking action because of this article!
What is an RRSP?
Let’s review the RRSP. It is a tax deferral. You take after tax dollars, invest into an RRSP, claim the amount invested as a deduction against your taxable income, and receive a reduced amount of taxes owing due to this. If your taxes owing goes negative, you get a refund. This in effect converts your contribution to a pre-tax investment.
Withdrawal Time (Retirement)
When you withdraw the money from your RRSP years down the road (i,e, retirement) , it is now taxable income. So you pay taxes on the withdrawal.
If you contribute when you are in the first tax bracket (income less than $50,197 in 2022), you save the 1st tax rate (about 15%). But if when you withdraw the money, your pension, CPP, OAS, GIS puts you into the second tax bracket, your RRSP withdrawal now is taxed at the second rate (20%). So by deferring the taxes, you are actually paying more taxes than had you invested in a non RRSP account.
TFSA
Contrast to a TFSA account. Once again, you take after tax money and contribute. The options to invest in are usually the same (or very similar) as what’s available in the RRSP, so lets pretend you bought identical investment funds within the accounts. For this comparison we will assume identical returns within the RRSP vs TFSA. When you take money out of the TFSA, you do NOT pay taxes on the withdrawal. You will have an extra 15% or 20% (or more) at withdrawal time.
Conclusion
At the end of the day (assuming same contribution date and withdrawal date), you keep more money coming out of the TFSA than out of the RRSP, UNLESS you also invest the tax refund. The power of compounding will make the RRSP worth more if you do in fact also invest the refund into your RRSP.
Now, if you are in a higher tax bracket at contribution time, the calculations change. This is why it is important to speak with an advisor!