Saturday July 26, 2014


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Back to basics

$mart Money
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I’ve been writing this column for a long time: 14 years, now. Occasionally I write about exotic things, but I also like to get back to basics from time to time.

There are a few reasons for that. One reason is because if you don’t understand the basics, you can’t build much. A second reason is that there a lot of people out there that don’t understand the basics. And, to be blunt, it’s not uncommon for people to overestimate their actual knowledge. Occasionally people are under the impression that they already understand a subject, but the reality is that their comprehension is incomplete.

Even people that are familiar with the basics can stand a refresher from time to time. Often I will attend a seminar on a topic that I am well-versed in, and I will still come away with a little something of value. Maybe a reminder, or perhaps a new perspective.

So given all that, this week we are going back to basics. We are going to talk about the splendour of the Registered Retirement Savings Plan.

RRSPs are individual retirement plans.  They are designed to encourage people to save for their own retirement.  RRSPs are one of the best wealth building tools available.

 An RRSP is not a specific investment product, but rather a vehicle that can hold a variety of investment options.  Some of the most common investment options include daily interest accounts, guaranteed investment certificates, Canada Savings Bonds, mutual funds, stocks, and bonds.

The huge inventory of RRSP-eligible investments is an important point.  I run into a lot of people who are under the impression that they can only invest in fixed term, fixed interest rate products for their RRSP.   There is a great big beautiful world of investment opportunities out there, and a person does not need to settle for a mediocre investment to get the benefits offered by a Registered Retirement Savings Plan.

Here’s the first benefit of using RRSPs.  Any money contributed to an RRSP is tax deductible, and RRSPs can save you a significant amount of tax.  Let’s say you make $100,000 per year.  Your tax bracket at this income level is roughly 40 per cent.  If you contribute $10,000 to an RRSP you will be able to deduct the $10,000 contribution from your gross income of $100,000, and owe tax on just $90,000.  You just saved about $4000 in taxes. 

Reducing your tax bill is great, and this is probably the primary reason why people make an RRSP contribution.  But it gets even better.  

The second great benefit of the RRSP is that as long as the funds remain inside the RRSP they are sheltered from tax.  For someone with a long time frame, tax sheltering the growth on the investment can be even more valuable than the tax deduction on the contribution today.

Let’s compare investing inside the RRSP with investing outside the RRSP. Say you are planning to invest $5000 per year for 20 years and you are going to earn a six per cent rate of return.  If the investment is made inside the RRSP, you do not have to pay any tax on the growth of the money until you take it out.  If the investment is outside of the RRSP you have to pay tax on the growth of the investment each year.

At the end of the 20 years the person who used the RRSP grew their investment to $194,964.  The person who did not use the RRSP, and paid tax all the way along, only has $148,003.  That’s a difference of $46,961 in favour of the RRSP, and that’s not even including the value of the tax savings at the time of the RRSP contributions.

There is an important difference between the two scenarios here. The RRSP investment that grew to $194,964 will face taxation on withdrawal, whereas the non-registered investment of $148,003 has already accounted for taxation.

This taxation of money on withdrawal from an RRSP leads some people to believe that RRSPs suffer from double taxation. They are wrong. The tax on withdrawal is the one and only time RRSP money gets taxed. It doesn’t get taxed when you put the money in, and it doesn’t get taxed as long as it is in the RRSP.

Perhaps more importantly, people who dislike RRSPs because of the tax at withdrawal are discounting the fact that the tax-friendly environment for RRSPs means that you accumulate so much more money than by investing outside the RRSP.

In my example, the RRSP investment grew to $46,964 more than the non-registered investment. Even if you do some really dumb things with the RRSP investment from a tax point of view, you are still likely to be farther ahead with the RRSP, simply because you grew the investment to so much more.

The simple truth is that most Canadians need to invest in something in order to achieve their desired retirement lifestyle. The Registered Retirement Savings Plan is one great option, and yet paradoxically most people are not taking advantage of the wonderful benefits of the Registered Retirement Savings Plan.

A few years ago Statistics Canada issued a study that illustrated why planning for retirement is so important.  Approximately one-third of all Canadians are facing a serious drop in their income at retirement

A rule of thumb is that to maintain your standard of living in retirement you may need about 70 percent of your pre-retirement income.  Many people believe that these funds are going to come from company or government pension plans, without realizing just how much these pensions will actually be paying.

Government programs such as the Canada Pension Plan and Old Age Security may be able to replace about 62 percent of income for those who make between $20,000 and $30,000.  This sinks to about 56 percent for those who make between $50,000 and $70,000 and to about 45 percent for those making more than $70,000.

So if we need about 70 percent of pre-retirement income, and the government benefits are not delivering, we have two options.  Either that money needs to come from another source, or we have to get used to the idea that our retirement years are not going to be as comfortable as we had hoped.

Two of the main methods of funding a person’s retirement are private pension plans and registered retirement savings plans, but many people are not utilizing these tools.  Statistics Canada found that more than 1.5 million families did not have a private pension plan. And only about four out of ten Canadian taxpayers contribute to a Registered Retirement Savings Plan.

All sorts of people are facing a financial shortfall in retirement. Not surprisingly, many low income families will face a retirement shortfall, but check this out: 41 percent of families earning more than $75,000 will not have enough money to have the retirement that they expect.

That may seem strange to some, that all these high-income earners not being able to afford the retirement that they expect, but really it’s not strange at all. You see, the reality is that there are many shiny things that people want, and it can be real easy to justify some purchases that will give us pleasure today when retirement seems so far off.

Here’s an eye opener for you. If you have 20 years to retirement, and you get paid twice a month, that’s only 480 paydays left until retirement. How much are you putting away per paycheque for retirement?

A little off-topic, but some food for thought - it’s not your income that determines your wealth, it’s your spending habits. Again, how much are you putting away per paycheque for retirement?

The hard facts are these- many, many people will still have money worries once they retire.  Difficult choices will need to be made.  It may mean delaying retirement, it may mean living on less.  Fortunately, it may not be too late for some.  But the longer a person waits the harder it is to catch up.

One great thing that you can do to plan for your retirement is to take advantage of Registered Retirement Savings Plans.  RRSPs are not the only tool available, and even RRSPs may not be enough for you to reach your retirement objectives.  But certainly your odds of having the retirement that you want are a lot better if you plan for your retirement using RRSPs and other wealth building strategies. 

RRSPs have one more compelling advantage at this time of year. You can “back-date” them in the sense of any contributions made in the first 60 days of the year can be claimed on the previous year’s tax return.  In other words, it’s not too late to save some tax for 2012. 

There is a saying- if you aim at nothing, that’s what you will get - nothing.   If you have not yet started planning for the future there is no time like the present.


The opinions expressed are those of Brad Brain, CFP, R.F.P. CLU, CH.F.C., FCSI.  Brad Brain is a Senior Financial Advisor with Manulife Securities Incorporated, in Fort St John, BC. Manulife Securities Incorporated is a Member of the Canadian Investor Protection Fund. Brad Brain can be reached at"> or

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