Apr 17: BEST FROM THE BLOGOSPHERE

April 17, 2023

RRSPs are still the best way to save for retirement: Golombek

At a time when many observers are saying the venerable registered retirement savings plan (RRSP) has been surpassed by other, newer savings products, noted financial writer Jamie Golombek begs to differ.

Writing in the Strathroy Age Dispatch, Golombek notes that some retirement commentators are asking if the RRSP “still has merit.”

“Let me try to un-muddy the waters by suggesting that RRSPs are likely the best way for many Canadians to save for retirement. After all, an RRSP, just like a tax-free savings account (TFSA), allows us to earn effectively tax-free investment income. And that’s not a typo: tax free, not merely tax deferred,” he writes.

So how is an RRSP tax-free? Golombek explains.

“If you go back to basics, and really think about what’s happening with an RRSP contribution, you will soon realize the investment return on your net RRSP contribution is mathematically equivalent to the tax-free return you could achieve with a TFSA, ignoring, for now, changes in tax rates. And, provided the time horizon is long enough, RRSPs can beat non-registered investing even if your marginal tax rate is higher in the year of withdrawal than it was when you contributed,” he writes.

He gives the example of Sarah, who has a marginal tax rate of 30 per cent and puts $1,000 into an RRSP.

“Applying (an) … annual rate of return of five per cent over the next 20 years, with no annual taxation, Sarah will be able to accumulate an RRSP worth $2,653. But, alas, not all the RRSP funds are hers to spend. The piper must be paid. When Sarah withdraws the $2,653 from her RRSP, and assuming her marginal tax rate is still 30 per cent, she will pay $796 in tax, netting her $1,857 after tax from her RRSP. This is equivalent to a five-per-cent annual after-tax rate of return on her $700 net initial investment ($1,000 contribution less $300 in deferred taxes on that initial investment),” he writes.

“In other words, Sarah’s after-tax rate of return of five per cent is exactly equal to her pre-tax rate of return, meaning she essentially has paid no tax whatsoever on the growth of her initial $700 net RRSP investment for 20 years. The RRSP allowed her to save for retirement on an effectively tax-free basis,” he explains.

If your marginal tax rate when you retire is lower than it was when you put the money in, you get an additional tax advantage, Golombek concludes. Did you know that the Saskatchewan Pension Plan operates very much like an RRSP? The contributions you make are tax-deductible, so you may get a nice little tax refund as a pat on the back for making regular SPP contributions. Check out SPP today!

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Jamie Golombek, Registered Retirement Savings Plan, RRSP, Strathroy Age Dispatch, Tax-Free Savings Account, TFSA

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