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Email this8:33 pm
April 20, 2019
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One contributes to an RRSP if one expects to be in a similar tax bracket, plus any clawbacks, on average, or lower later as when one deducted the contributions.
If one ends up paying the same tax rate on the withdrawals, then the RRSP is equivalent to a TFSA. Detailed calculations are in this previous discussion.
The RRSP can still be better if one pays a slightly higher rate on the withdrawals.
In one case, $400,000 of contributions, deducted at 32½% average, with the $1.3 million of withdrawals taxed at an average of 40%, results in paying just 16.05% in taxes on the gain of $900,000. That would be the case outside the RRSP had the gains been capital gains.
Thanks Norman. I guess the logic being the tax deferral on the most efficient compounding investment returns would make up for the slightly higher tax rate on withdrawal when compared to non registered account investment returns.
11:44 pm
October 21, 2013
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If Bill and Doug have their way, your tax rate in retirement will see a whopping increase to pay for the Covid economic measures. This will play havoc with Norman's calculations.
The point is always that you don't know what is coming when you retire. A bird in the hand etc.
Accordingly, my philosophy, now that I have been retired several years and am in my 70s, is that such government progrrammes are likely best avoided. What the government invents, the government controls and can manipulate to suit itself.
I regret that we ever participated in RSPs. So far we are OK with TFSAs, but I am cautious about them. I think we could have made better use of our RSPs if I'd understood them as well in the past as I understand them now.
In my opinion, they are not a retirement scheme per se; they are an income averaging plan. Once you understand that, you can make better use of them. But you need to remember that tax brackets, tax rates, tax credits, tax deductions, mandatory minimum withdrawals, allowable investments, and clawbacks are all subject to change, and probably will. They have all changed since I made my first RSP investment.
I think the only thing that hasn't changed is the tax treatment upon death of second spouse, wherein CRA taxes the residue at top marginal rate (which is itself subject to change), thus putting the lie to the calculations you are currently making about what it will cost in the end. They are useful if one is planning some time out of the work force to return to school, travel (remember travel?
) or raise children etc - all examples of income averaging.
I wish someone had explained this to me when I was younger.
One thing that is guaranteed is that rules will change by the time you want to access these funds. One thing that will not change is that the RSP/RIF will carry a tax liability for you, which should be deducted from estimates of net worth. The risk is in extrapolating from the present and making assumptions you aren't aware of until the basis for them changes.
Good luck!
2:04 am
April 15, 2020
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suburbs4life said
One contributes to an RRSP if one expects to be in a similar tax bracket, plus any clawbacks, on average, or lower later as when one deducted the contributions.If one ends up paying the same tax rate on the withdrawals, then the RRSP is equivalent to a TFSA. Detailed calculations are in this previous discussion.
The RRSP can still be better if one pays a slightly higher rate on the withdrawals.
In one case, $400,000 of contributions, deducted at 32½% average, with the $1.3 million of withdrawals taxed at an average of 40%, results in paying just 16.05% in taxes on the gain of $900,000. That would be the case outside the RRSP had the gains been capital gains.
Thanks Norman. I guess the logic being the tax deferral on the most efficient compounding investment returns would make up for the slightly higher tax rate on withdrawal when compared to non registered account investment returns.
I tried to compare RRSP to TFSA. It is difficult since the rules changed over the years. My calculations are TFSA is MARGINALLY better over the long term. Altering the assumptions could make RRSP marginally better. A RRSP/RRIF is an income averaging tool.
9:36 am
April 6, 2013
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Norman1 said
…The RRSP can still be better if one pays a slightly higher rate on the withdrawals.In one case, $400,000 of contributions, deducted at 32½% average, with the $1.3 million of withdrawals taxed at an average of 40%, results in paying just 16.05% in taxes on the gain of $900,000. That would be the case outside the RRSP had the gains been capital gains.
suburbs4life said
Thanks Norman. I guess the logic being the tax deferral on the most efficient compounding investment returns would make up for the slightly higher tax rate on withdrawal when compared to non registered account investment returns.
It is not really the tax deferral. It is more that the first 32½% of the 40% tax owing on the withdrawals is just repayment of the tax refunds from the RRSP contribution deductions and of the growth of those tax refunds in the RRSP.
Of the 40% gross income tax on the withdrawals, the net income taxes paid is only from 32½% to 40% or 7½%.
Without understanding that, people will mutter that they got screwed by the RRSP. They will complain in error that they now pay 40% tax on the capital gains in the RRSP when they withdraw the capital gains, instead of 32½% x 50% = 16¼% had they invested the same outside the RRSP. They will complain in error that they lost the benefits of the dividend tax credit and the dividends are taxed as regular income when withdrawn!
9:43 am
April 6, 2013
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cruzinalong said
I tried to compare RRSP to TFSA. It is difficult since the rules changed over the years. My calculations are TFSA is MARGINALLY better over the long term. Altering the assumptions could make RRSP marginally better. A RRSP/RRIF is an income averaging tool.
It is quite complicated because the benefit of the RRSP/RRIF depends on the
- the average tax rate when the RRSP contributions were deducted,
- the average tax rate when the RRSP/RRIF withdrawals will be taxed, and
- the amount of growth in the RRSP/RRIF.
One way of looking at the TFSA and RRSP/RRIF choices is to think of the TFSA as a special case of the RRSP/RRIF, where #1 and #2 are the same.
11:43 am
April 15, 2020
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I worked for a company that had a savings plan. I contributed to RRSP from pay. The tax savings were 36%-38%. Put $100 in RRSP net pay dropped to $64-$62. Once I kept slips for years. I realized you do not need any of slips. I trashed all of them.
1:10 pm
March 30, 2017
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Norman1 said
cruzinalong said
I tried to compare RRSP to TFSA. It is difficult since the rules changed over the years. My calculations are TFSA is MARGINALLY better over the long term. Altering the assumptions could make RRSP marginally better. A RRSP/RRIF is an income averaging tool.
It is quite complicated because the benefit of the RRSP/RRIF depends on the
- the average tax rate when the RRSP contributions were deducted,
- the average tax rate when the RRSP/RRIF withdrawals will be taxed, and
- the amount of growth in the RRSP/RRIF.
One way of looking at the TFSA and RRSP/RRIF choices is to think of the TFSA as a special case of the RRSP/RRIF, where #1 and #2 are the same.
If one's marginal tax is expected to be the same (say 40%) both pre and post retirement, and whats inside the RRSP are mostly capital gain and dividends, I thought keeping it outside RRSP in the first place would have been a better total return at the end ?
1:48 pm
September 11, 2013
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cruzinalong, I think the vast majority of people don't do these calculations, etc, it's too much of a guess at a bunch of variables & future unknowns, so they just buy RRSPs along with whatever other saving and investing and home buying and bill paying, etc choices they make that suit them. That's what I did, never really did much calculations about anything, though I remember with RRSPs having the vague feeling they might cost me more later but I wasn't sure plus I just liked RRSPs because that money was unofficially not available to raid so it just kept building, nice feeling. To me it was more important to make as much money as possible, e.g. the decision to be mainly in the stock market vs GICs was more important to my position today than whether or not to do it within or outside an RRSP (p.s. I'm not confident about the market going forward but it was great during the decades that mattered to me). So, luckily, I end up with comfortable retirement income, lots of credits not available to me, no GIS, no GST credits, I've got surtaxes to pay, and so on. But I've no regrets as my life is financially comfortable, that was the ultimate goal and it happened for various reasons not just my saving and investing history (e.g. no marriage splits, no stupid spending, well-paying work, no extended periods of unemployment, raising children that were financially independent adults at a young age) so I certainly don't waste any time thinking if I'd done it differently I could have a few more bucks in my pocket. Just another perspective for you.
4:21 pm
April 15, 2020
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I have lots in common with you. Pleased that there are individuals that agree. The stock market started the year on rocky footing. In the short run I expect more of the same. The dividends keep coming. The dividends increased as usual in a couple companies I invest in. We will prevail.
9:05 pm
April 6, 2013
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savemoresaveoften said
If one's marginal tax is expected to be the same (say 40%) both pre and post retirement, and whats inside the RRSP are mostly capital gain and dividends, I thought keeping it outside RRSP in the first place would have been a better total return at the end ?
I used to believe that too. But, it actually is not the case.
It is a myth that one pays any net taxes when the tax rate on the RRSP contribution deductions is the same as the tax and clawback rates on the later withdrawals.
I realized that those people who liked to get quoted in the media and suggested keeping equity mutual funds and stocks outside RRSP's didn't know what they are talking about.
I have no hesitation now investing having equity mutual funds and dividend paying stocks into my RRSP.
9:11 pm
April 6, 2013
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cruzinalong said
I worked for a company that had a savings plan. I contributed to RRSP from pay. The tax savings were 36%-38%. Put $100 in RRSP net pay dropped to $64-$62. Once I kept slips for years. I realized you do not need any of slips. I trashed all of them.
The impact of the payroll RRSP contributions on the tax withheld is a very rough approximation. One needs to look at the tax return those RRSP contributions were deducted on to determine what the contributions actually saved. That return may not be the return for the year the contributions were made.
The savings may be more if there was a windfall that pushed one up a tax bracket. The savings may be less if one had other deductions that lowered one's tax bracket.
7:31 am
April 15, 2020
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True. I remember getting a profit sharing cheque. It pushed me into the next higher marginal income tax bracket of 42%. When I filled my income tax return the following year I got an additional 4%-6% saving.
2:22 pm
March 30, 2017
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Norman1 said
savemoresaveoften said
If one's marginal tax is expected to be the same (say 40%) both pre and post retirement, and whats inside the RRSP are mostly capital gain and dividends, I thought keeping it outside RRSP in the first place would have been a better total return at the end ?
I used to believe that too. But, it actually is not the case.
It is a myth that one pays any net taxes when the tax rate on the RRSP contribution deductions is the same as the tax and clawback rates on the later withdrawals.
I realized that those people who liked to get quoted in the media and suggested keeping equity mutual funds and stocks outside RRSP's didn't know what they are talking about.
I have no hesitation now investing having equity mutual funds and dividend paying stocks into my RRSP.
Thanks Norman. The difference is coming from being able to invest $1k inside RRSP vs only $600 outside after tax. So the RRSP is always better off as long as return is positive. If return ends up negative, then the ability to claim capital loss outside RRSP will have the upper hand.
5:46 pm
October 21, 2013
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If you have a loss on your RSP, then you never pay a cent of tax on that loss. Seems fair enough to me.
8:16 pm
March 30, 2017
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Loonie said
If you have a loss on your RSP, then you never pay a cent of tax on that loss. Seems fair enough to me.
I am thinking the following scenario:
$2000 available for investment
tax rate = 40%
Scenario 1:
Divide $2000 equally into RRSP and non-RRSP. This results in $1000 in RRSP and $600 in non-RRSP initially.
Inside RRSP $1000 investment, stock goes to zero
Outside RRSP $600 investment, stock goes to $1200 (double the money)
tax = $600 * 0.5 * 40% = $120
Total asset (both inside and outside RRSP) = $1080
Scenario 2:
After income tax, $1200 available for investment
Outside RRSP $600 investment in stock A goes to zero
Outside RRSP $600 investment in stock B goes to $1200 (double the money)
Tax = $0 ( since $600 capital gain offset by $600 capital loss)
Total asset = $1200
So even though you never pay tax on the $1000 inside the RRSP that ultimately goes to zero, you are still worse off.
9:37 pm
October 21, 2013
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Sorry, but what you are saying doesn't make sense to me.
It's probably not worth your while trying to pursue it with me further because the issue is not important to me.
1:55 am
February 27, 2018
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I doubt anyone here has an overall tax rate of 40%. Taxes are tiered as i stated in an earlier post. To experience an overall tax rate of 40% you need an income of $290,000.
https://www.taxtips.ca/calculators/canadian-tax/canadian-tax-calculator.htm
What does tiered mean?
https://www.taxtips.ca/taxrates/on.htm
You pays 20% tax on the first $45,000 of income you make
You pay 24% tax on the next $4,000 you make. Income now $49,000.
You pay 30% tax on the next $30,000 you make. Income now $79,000
You pay 32% tax on the next $10,000 you make. Income now $89,000
Another clear point i tried to make. Your income over your working life will increase. In 1980 a 1st class constable on the Toronto police force made $25,000. In 2019 a 1st class constable on the Toronto police force made $100,000.
http://www.torontopolice.on.ca.....nefits.php
I understand you have more money to invest inside your rrsp (1,000 vs 600). This also gives you more money to be taxed at your "40%" when you pull it out. The money you pull out of your rrsp is ADDED to whatever income you have, putting you in an even higher tax bracket. Pension, investment income, whatever else you have, gets added to your rrsp withdrawal.
In the 80's i had a 5 figure income. Retired, with all sources of income added (including rrif withdrawal) i have a 6 figure income. My 2020 pension alone, is more than my 1st years income.
An Rrsp is not for everyone. It's not for me.
5:59 am
September 11, 2013
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Agreed, RRSP certainly doesn't make sense for lifelong unionized public sector aristocracy, particularly if partner in same boat.
I always figured if I having a RRIF irritates me too much some day then I'll just take it all out one year, pay a whack of taxes, and get back to not being irritated. Always an option. Then I find out some old folks like their irritation, it's like their remaining lifelong friend, so maybe I'll end up like that!
6:30 am
March 30, 2017
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Norman did the math and I concur the benefit of RRSP. Its math after all, no need to guess or estimate.
Choosing a marginal tax rate of 40% instead of overall tax rate is more meaningful in the comparison.
I also agree if one does not earn at least 6 figure, the benefit of RRSP vs TSFA is not as dramatic, but the math shows it still provide net tax benefit. The marginal tax rate is irrelevant in the sense it is meant to show how much one can benefit, not whether one benefits or not.
The situation becomes quite complicated if one wants to factor in potential OAS clawback etc due to RRSP withdrawal counted as income.
7:35 am
February 27, 2018
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You can not use a marginal tax rate of 40%, not on earth anyway?
1) putting money into an rrsp draws down a tax rate.
2) withdrawing money from an rrsp increases a tax rate.
Believe it or not, the two oppose each other.
A Toronto police officer in 1980 fully utilizing the rrsp. Could have maybe put $2,000 into a plan. The rate was 10% back then, minus the company pension offset. So income tax would have been based on, $23,000
In 2020 that police officer is now retired (i could not find a pension amount) i figure a pension of probably $60,000 to 65,000 a year. Now they are adding rrsp money onto to that $60,000. How could there possibly be a benefit of starting an rrsp back in 1980?
using the past as a reference. If you're making $100,000 a year today, you might be looking at $300,000 a year, in 30 years time.
Please write your comments in the forum.