RRSP—Is it a good really a good investment for retirement?

RRSP—Is it a good really a good investment for retirement?

Most middle or upper income earners buy RRSP’s on a regular basis. Banks flood their buildings with reminders and promotions to encourage their customers to buy before the deadline. February is RRSP month according to every financial institute in Canada.
Investors are listening to their financial advisors telling them to buy RRSP’s. Advisors are showing statistical comparisons that show how thousands of extra dollars can be saved by retirement. Banks have free advisors to help you make the right choice and maximize your RRSP investment.
Can you or should you trust all this advice?
Would you ask an insurance Agent to advise you about the amount of coverage you need? Whose interest is actually being cared for? If someone is an expert on insurance, does that mean the advice given will benefit you?
Robert Kiyosaki in his best selling book “Rich Dad, Poor Dad”, takes the view that professional financial advisors give advice that is more in their own interest than yours. He points out investors need to evaluate advice not just accept it because the advisor calls himself an expert.
What are RRSP’s? The RRSP plan has been put in place by Canada Revenue as a government plan to encourage people to save for retirement and not be dependent on the Canada Pension Plan. RRSP’s is an intended investment plan but can be used for savings. For instance new home owners can use this plan to finance their first home purchase.
If you look on the internet, you will see the words save and invest are equally used in the investment community. The terms are quite different. You save for a rainy day, which implies a shorter time than investing for the future. An investment is associated with a degree of risk in some longer-term purchase of an asset for a return.
For nearly a hundred years Canada Savings Bonds and War bonds have been bought by many employees not because of their return but the convenience for saving. The new choice for saving is RRSP’s which encourages people to save by reducing their taxes.
RRSP’s can be a real benefit to those who take a leave or have a low-income year. A number of people have used RRSP’s to start up a business or new career. A new entrepreneur will have cash for their new business and be able to benefit from paying little taxes when their new business has slow start up sales. As an investment capital source it is much more attractive than home equity-- particularily when a couple owns a home jointly and one partner’s entrepreneurial spirit may seem risky.
As a savings, RRSP’s can be a great choice.
When we look at RRSP’s as a long-term investment for retirement, it is quite different. For an individual who is not easily distracted and determined to maximize their retirement benefits, RRSP’s are not the best choice. We have all heard of the term “if it sound too good to be true, then maybe it isn’t”. RRSP’s fit this category.
Let us make a fair comparison. If we use as our typical investor a professional or skilled trade worker with a $70,000 income and her or she wants to invests a tidy $10,000 into RRSP’s. He or she could expect to get $3000 back in taxes.
I have rounded off the figures in this illustration to simplify reading and in appreciation that the many small variables do not justify using unrounded figures. I am also going to assume for comparison that all investments and returns are at a conservative 5%.
If a 30 year old were to invest $10,000 a year for 30 years with plans to retire at 60 he or she would have saved $660,000. The individual who does not invest in RRSP’s would have only $7000 a year to invest over the 30 years in order to keep the same disposable income level. This would end up being worth $466,000.
While the RRSP investor would have $200,000 more, they would need to pay taxes on their investment. In fact the RRSP’ converted to RRIF’s and paid over 30 years (until the investor is 90) the investor would get an extra $40,600 a year in taxable income. The taxes on that extra income would be $6800 a year. That is over $200,000 in taxes that would need to be paid.
If you were take this money out in a shorter than 30 year time. The taxes would be even greater. So where is the RRSP advantage?
Most investment counselors who show comparisons will assume the non RRSP investor will purchase products they sell like mutual funds or GIC’s. The interest returns on these are taxable. If you intend to invest in these, RRSP’s may be a better option.
I am assuming a wise investor will use their $7000 yearly savings to pay down their mortgage. Almost all credit unions and some banks do allow for yearly pay down payments.
However, it gets even better. When you pay down your mortgage, you increase your equity. With increased equity, you can buy a bigger house for personal use and investment. If we say in 10 years, you want to upgrade you would have $70,000 more in equity. If you keep your mortgage at 75% you would have in effect $210,000 more in house value that you could purchase. I am assuming our investor is willing or wanting to spend more disposable income for more home.
If we use the figure of the average home in the lower mainland over the last 30 years increasing an average of 6.7% we can calculate the increased value of your asset. Having a house that is $210,000 more in value would mean that in the next 20 years your increase asset value would be worth $281,000 more. This is a non taxable capital gain of $281,000.
Not investing in RRSP would put you $281,000 ahead in my conservative estimate. It would put you in a better home. It would give the flexibility to choose when and how you want to use you retirement investment. For instance you could use the capital to buy a resort village and not just visit one.
Retirement can be like winning a million dollar lottery. With no RRSP’s you can have the million now or over the next 30 years if you buy RRSP’s. In my example if each started with a $400,000 home the RRSP investor would after 30 years have a $800,000 paid off home and an extra taxable income of $40,000 for the next 30 years. The non RRSP investor will have a $1,300,000 non taxable asset ($800,000 paid off home, $281,000 capital gain from larger home, and $210,000 extra paid off his mortgage).