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Moncton Times & Transcript ~ Tax Help Plus ~ RRSP Deadline ~ February 27, 2007 - 25 Feb 2007 by TaxHelp
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RRSP Deadline.
Roger Haineault – “Tax Help Plus ...” – February 27, 2007.
You may not have heard but the Registered Retirement Savings Plan (RRSP) deadline for contributing to impact last year’s tax return is coming up this Thursday, March 1. I’m sure the volume of advertising will progressively increase as the week wears on.
The hard facts are as follows: contributions are limited to 18 per cent of your 2005 earned income to a maximum of $18,000. In addition, you may have available room from previous years where you did not maximize your contributions, so that for some, a house could literally be bought with the deposit (in addition to being bought using the Home Buyers Plan). Conversely there are those who have contributed in the past but not taken the deduction (for a variety of reasons). These people may now claim the write-off without laying out another penny. If you check last year’s Notice of Assessment which was mailed to you following the filing of your tax return you will be able to uncover your situation. Call the office if you need help reading it.
One of the keys to understanding the tax system and investing in general is to grasp the sometimes confusing concept of marginal tax rates. RRSP contributions are deducted from your marginal rate, making for a greater impact to those with higher incomes. While the $1,000 contribution might be the same across the board, for some the real cost will be $750 while for others it will be closer to $530.
The whole RRSP conversation leads to a discussion of investing. The first thing you should understand is the “Rule of 72”. Basically, this little formula tells you how long it takes for money to double. You take the interest rate you earn and divide it into 72. If you earn 10 per cent, money doubles in about 7.2 years. If you earn 20 per cent money doubles in about three and a half years. If you earn 5 per cent money doubles about every 14 years. So simply put, if you have $10,000 today and can earn 15 per cent, in about five years you have $20,000. In ten years that sum has grown to about $40,000 and in about 15 years it’s about $80,000. Put another way, someone 40 who puts $10,000 away and leaves it there and can earn 15 per cent will have about $320,000 at 65, using this little napkin math formula.
RRSPs are the best tax deferral device available to the average Canadian. Sometimes I hear that they’re no good because of the big tax bill at the end. But let’s really look at the numbers. Let’s use these assumptions – the taxpayer is in the lowest tax bracket, which has a combined federal – provincial rate of something just north of 25 per cent and can make a $200 a month saving deposit and can earn 10 per cent over the 30 years until retirement. If he does not buy an RRSP, he must pay tax on the interest as it is earned. This means that his savings after tax will grow to about $255,000. However, if he buys an RRSP, he gets an immediate tax deduction giving him an additional tax refund of about $600. Plus, his savings grow tax deferred. In other words, he doesn’t have to pay tax on the growth while it’s in the RRSP. So what does the same investment do within an RRSP? $416,169! And that’s not the end of the story! If he takes the $600 refund and invests it at 10 per cent in some mutual fund as an example, it grows to over $66,000. The bottom line is with the RRSP and refund savings at retirement our friend is looking at over $480,000. If he withdraws the funds systematically from the RRSP the tax bill could be as low as $106,000. So after tax in the first case, the guy has $255,000 while the second guy has more than $375,000 – all from a simple $200 a month investment.
While many people would think that a return of 10 per cent is non-existent these days, there are in fact a number of readily available mutual funds that have just that kind of performance history. This is not to suggest that you should run out and buy either of these two investments but both Standard Life and Bank of Montreal have a dividend based fund that has returned over 15 per cent annually since they started back in 1994.
For the risk tolerant investor who purchases a labour sponsored fund like GrowthWorks Atlantic Venture Fund, there is an additional credit that may be claimed. Traditionally these have been bought as RRSPs. When they were first devised they had a 20 per cent tax credit federally and provincially. These funds had to be left in for five years. For the past number of years the credit has been reduced to 15 per cent federally and provincially. This has to be balanced by the fact that you are tying up your funds now for eight years, and may be giving up on greater returns elsewhere. Talk to your investment professional about your options. On a maximum qualified RRSP contribution of $5,000 the deduction and available credits may put the actual out-of-pocket expense into the $1,200 range. Either the contributor or the annuitant (which usually is the contributor’s spouse, if it is not the contributor) may take the tax credit.
While many people in business get to take advantage of tax relief the old-fashioned way by investing in their operation, and have little available dollars for true investing, the average individual needs to look at a way of forwarding dollars to his or her future. For your information, the Old Age Security last year paid a princely $5,706, enough to fund a trip to watch the Blue Jays in spring training, where hope springs eternal, but difficult to live on.
Roger Haineault is with Tax Help Inc. His column "Tax Help Plus ..." appears each Tuesday. For questions, comments or column suggestions he can be reached by calling 855-HELP (4357) or by emailing roger@help4taxes.ca |
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