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Fredericton Daily Gleaner ~ Capital Appreciation ~ Too little RRSP ~ February 12, 2007 - 25 Feb 2007 by TaxHelp
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We are about to be inundated by the annual Registered Retirement Savings Plan (RRSP) advertising season. And almost everyone has an opinion as to whether they are worthwhile.
Without a doubt, purchasing an RRSP is the best tax advantaged program that is available to the average person out in the workforce. The annuitant-purchaser ends up with a tax deduction at his marginal rate – that is the highest rate of tax that he pays. A contribution of $1,000 for someone earning about $30,000 saves about $250. If you are in the $50,000 taxable range, the same $1,000 saves about $370 in taxes, while someone at $75,000 saves $425. So as you can see the more you make, the more you save by contributing, leaving a lower net cost to the funds you are sending into the future.
However, the real advantage to RRSPs is the tax deferred growth. Money that is not registered (and in the trade is referred to as open) attracts tax each year on the growth. While capital gains and dividends are tax advantaged, interest income is not. In any event, the (hopefully) ever increasing open funds are always being reduced by the taxes they are attracting. RRSPs are not taxed until they are withdrawn, thus enjoying the true magic of compound interest, which we’ll leave for another day.
Put another way, if someone could invest $200 a month for 30 years at 10 per cent (I know, but they are out there) the person who does this following the non-registered route will have a kitty of $258,240 at the end of the period assuming he or she is at the lowest tax rate of 25 per cent. On the other hand, the same scenario being contributed into an RRSP will generate an amount of $416,170 plus a tax savings of $600 a year, which if it were re-invested in an open source would grow to $62,040. Granted the $400K would be taxable, but with the new income splitting rules if it were split between spouses, the investor would be farther ahead, even though the quarter million is sitting tax free. By the way, it will be interesting to see the impact these new rules have on the sales of spousal RRSPs.
So you would think that this is an open and shut case! But someone pointed out an interesting article to me last week that may cause people to re-evaluate their options. Bruce Cheadle, a Canadian Press reporter had a story out at the end of January that talked about the challenge a Moncton resident had and the potential negative effects RRSP income could have.
In Canada we have a myriad of social benefits that low income residents can take advantage of like the Old Age Security (OAS) and the Guarantee Income Supplement (GIS). However these programs are ultimately income tested and clawed back as income increase – including RRSP payouts.
The story made the point that if you did not have a great amount of money in your RRSP, it may not be worth it to take in small amounts of money at retirement. Take as an example someone 65 who receives Canada Pension Plan (CPP) retirement benefits in the amount of $500 a month. This individual is entitled to combined OAS and GIS payments of about $875 a month for an annual income of $16,500. Here in the province, single seniors are entitled to belong to the Prescription Drug Program where they only pay $9.05 per prescription. However, singles with annual income of more than $17,198 fail to qualify and for some this could be catastrophic.
By some accounts a recipient loses fifty cents on the dollar if there is other income to claw back and other mechanisms. The lowly RRSP is also taxed, so that savings may only reap a true twenty-five cent bang for every buck of retirement funding. For those with company style pensions, these points are moot since their incomes tend to be higher and therefore not GIS or drug plan qualified. How do some low income wage earners avoid the issue? By cashing in all of their RRSPs before they retire. Sure there is a bigger tax hit. However, one ends up with some money in the bank and a greater dependence on qualifying for all the government sourced funds.
But such a drastic move should only be contemplated if you have an insufficient nest egg to fund your retirement. In the story it is suggested that the minimum holdings in the RRSP should be $100,000. If not, cash it and enjoy it – or wait for a rainy day. Finally, just like the wealthy hire tax planners to take advantage of the system, the low income should consider this their opportunity to maximize their retirement and security.
By the way, we still have a few times left for any group looking to have someone come out and offer a session where we discuss the newest tax changes. These events usually run somewhere around an hour once a question-and-answer is completed and are offered both during the day and evening. Most important, there is no charge for this service.
Roger Haineault is with Help 4 Taxes. He can be reached by email at roger@help4taxes.ca or by calling 1 (888) 450-1212. His column appears Mondays.
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