- Will your savings put you where you want to be in 5, 10, 20, 25
- Will you wait until it is too late to find whether you made the
right, or the wrong choice?
- Do you know that 78% of Canadians do not have enough funds to retire
- Do you know how much you will need to retire on?
Tax Sheltering Explained
RRSPs are one of the few ways that
ordinary Canadians can get a meaningful tax break. Earning money is hard and if you don't plan carefully, the
government will take much of your hard earned money and do some serious damage to how much you will be able to accumulate over
the long term.
However, you can greatly reduce the tax you pay — both
on your income and on your investments — and accumulate a lot more over a
lifetime with an RRSP. Here is a look at how the tax–deferral available
with an RRSP can help you build your wealth.
When you contribute
money into an RRSP, that contribution amount is deducted from your taxable
income when you calculate how much you owe Revenue Canada at the end of
the year. Say your taxable income is $60,000. Put $10,000 into your plan,
and Revenue Canada will assume that you only made $50,000. If you are in
the highest tax bracket — approximately 50 per cent — your tax bill would
drop from around $30,000 to $25,000. You end up with $5,000 more in your
But look at it another way. Let’s follow the
example above — you make $60,000 a year and pay approximately 50 per cent
tax, leaving you with about $30,000 and if you don’t qualify for any other
tax savings, your living costs take up $25,000 of your after–tax dollars.
If you neglected to make an RRSP contribution, you’d have just $5,000 left
over to add to your savings.
Now look at what happens if you put $10,000
into your RRSP. That cuts your taxable income down to $50,000, meaning a
tax bill of around $25,000. And that leaves you with $35,000 after–tax.
Subtract your living expenses of $25,000, and you’re left with $10,000.
So without using your RRSP you would have
$5,000 left over; with an RRSP, $10,000. That is a big difference. (In
fact, your savings are equal to what you contribute times your marginal
tax rate). If you were in the lowest tax bracket of around 27 per cent, a
$2,000 contribution would save you about $540 in taxes. In essence, the
government is subsidizing your contribution.
So the first benefit of an RRSP is that you can
put more away, simply because you’re working with tax–free dollars. The
real boost comes when you start to add up how much more you can put away
each year, and project that out over several decades.
This is the
second boost an RRSP will give your savings. Whether your investments earn
you interest, dividends, or capital gains, you don’t have to pay tax each
year on the money you make inside your plan. Rather than having to share
your good fortune with the government, you can take every penny you earned
and reinvest it. (Technically, this is known as tax–free compounding.)
This will have a snowball effect on your savings.
How fast will your savings grow? A handy
rule–of–thumb is that an investment earning 10 per cent will double
approximately every 7 years. So if you had $10,000 earning 10 per cent,
and you could reinvest all your profits after 7 years, you would have
around $20,000. After 20 years, $40,000. And after three decades? An
impressive $80,000, all thanks to your $10,000 initial investment, and the
power of tax–free compounding.
Using your RRSP to Buy a
Home In 1992, in the depths of recession, the
federal government decided to help people buy their first home by allowing
them to borrow up to $20,000 tax– and interest–free from their RRSPs. This
is another excellent reason why young individuals should maximize their
RRSP contribution so that they can withdraw up to $20,00 each ($40,000 per
couple) towards a home purchase without having to pay any immediate
earnings can grow
Compare a $5,000 annual investment over 30 years - one inside an RRSP, the other outside.
Assume a 10% annual return and a marginal
tax rate of 50%.
Thus, with a total contribution of $150,000, you would earn about $313,000 outside an RRSP, and $815,000 inside an RRSP - a whopping $502,000 difference!
How long will your
reitrement savings last?
Let's say you are planning to start
your retirement in January of 1999 and will be withdrawing $3,000 out of
RRSP each month (assuming a steady 10% return on your investments).
you start your retirement with $250,000 in your RRSP, you will have
$51,844 left after 10 years (including the 10% return you would have
earned in that time).
However, if you manange to save $500,00 in your
RRSP, it is a different story. Even with monthly withdrawals, by
the year 2009 your savings will have actually increased to over $700,279
and will continue to grow!
Investing regularly in a tax-shelter investment like an RRSP can
huge dividends over the long term. Look how much $100 a
(earning 10% annually) can grow to become.
The Sooner, the
Let us say Jane starts investing $2,500 a year
starting at age 20, but John waits until he is 35 to start investing the
same amount. If they both earn a 10% return on their investments, Jane
could potentially earn 3 times the amount of John's retirement
fund, even if she stops contributing at age 35.
How $1,000 would have
$1,000 invested in the Toranto Stock Exchange 300
Composite Stock Index (growth securities) in 1956 would have grown by June
30, 1998 to $56,203. In the same time frame, $1000 invested in the Scotia
McLeod Long Term Book Index (fixed income securities) would have grown to
about $33,130. A $1,000 purchase of 3-month Treasury bills (cash and cash
equivalents), would have grown to only $18,593.
You will not
have to pay any fees to MoneyWI$E Financial Inc. for us to provide the
above mentioned advice if you purchase mutual funds, stocks, bonds or GICs through us. .