I didn't think she was saying that you would be farther ahead by not contributing to an RRSP. Which point are you referring to specifically?
It was point 8 on her list. When I went back and reread it, it wasn't clear to me quite what she was saying. (She seems like a very fuzzy thinker to me. At least she writes as if she is.) Something about if I make a killing inside my RRSP then I will pay a lot of tax in the end. Well, yes, if I make a lot of money I pay a lot of tax. Actually, my goal in life is to have a huge tax bill!
I ran through the numbers again. Every time I do it it astounds me. Let's simplify things a bit. Suppose my allowable annual RRSP contribution is $10,000 and my marginal tax rate is 50%. So my actual cost per year is $5,000. What I need to compare then is the difference between investing $5,000 outside the RRSP per year with $10,000 per year inside. Let's also suppose that I am Warren Buffett, so that if I invest outside my RRSP I don't sell anything until retirement. (This is also a good strategy from a tax deferral perspective.)
The calculation is easy and I don't even have to account for the percentage increase on my investment, since I will invest exactly twice as much inside the RRSP as outside. So this means that after 30 years (say) my principal will be exactly twice, if I assume that I make the same yearly percentage increase in each case.
Now let's assume that I cash in the whole investment and that this is at my marginal rate, again 50%.
A) Outside the RRSP. My principal is X dollars. The tax I pay is 50% of 75% (capital gains), so I end up with 62.5% of X dollars.
B) Inside the RRSP. My principal is 2X dollars. Capital gains does not apply, so I pay a full 50% of my principal, leaving me with X dollars.
In summary, scenario B) leaves me with 60% more than scenario A). So, if for example investing outside the RRSP left me with 1 million after tax, then investing inside would give me 1.6 million after tax.
Now, in practice, I probably would not invest for 30 years without selling. So, then if I invested outside the RRSP I would be incurring capital gains along the way, reducing my principal further widening the gap between the two options.
Also, it's highly unlikely that I would simply cash in my RRSP upon retiring, but would spread it out over the 19 (?) years allowed. If I had no, or little, other income then not all of this would be taxed at my marginal rate.
Of course, all of the above does not take into account changes in RRSP rules and tax rates over the years. However, changes in tax rates would affect both scenarios.
Still not convinced of the advantage to maxing out your RRSP?
Piper |
