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Today I will discuss whether having an RRSP account as a Canadian is really worth it compared with a non-registered account. To begin with, let's talk about what an RRSP account is.

What's An RRSP Account?

An RRSP stands for Registered Retirement Savings Plan. The easiest way to think of them is as a tax-deferred plan, in which you save money on your taxes today, but will have to pay taxes later. To easier understand this, consider the following:

You made $50,000 income this year and paid $10,000 in taxes (20%).
You deposit $10,000 in your RRSP account.
When filing your taxes the following calculation is done: $50,000 income - $10,000 contribution = $40,000 true income.
Consequently, $40,000 x 20% taxes = $8,000.
Since you've paid $10,000 in taxes the government will refund you $2,000 so that you've paid the correct amount of taxes.

The actual calculations are slightly different and depend on your income, but the above example is just for simplicity in understanding how an RRSP works.

The benefit of this of course is now you have the $10,000 you deposited in your RRSP and an additional $2,000 in your account. There is a downside however, when you withdraw the funds the following happens:

You made $50,000 income this year and paid $10,000 in taxes (20%)
You withdraw $10,000 from your RRSP account.
When filing your taxes the following calculation is done: $50,000 income + $10,000 withdrawal = $60,000 true income.
Consequently, $60,000 x 20% taxes = $12,000.
Since you've paid $10,000 in taxes the government will ask you to pay $2,000 extra so that you've paid the correct amount of taxes.

Again, the actual calculations are slightly different but for simplicity sake we can see that a withdrawal has the exact opposite effect as a deposit, in that it synthetically raises your total income and that $2,000 refund you received last time is countered.

There is an appropriate way to use an RRSP - when your income is little to none. When your income is lower, your tax bracket is lower, and that's where you reap some of the reward. If you had withdrew the RRSP in a year when you had no income, then your tax % would be less and you would keep the difference permanently.

Another way you benefit from an RRSP is by investing both the deposit you make ($10,000 in our example) and the refund that you receive ($2,000 in our example). By doing this you're earning on additional money that you would not have otherwise had, and when withdrawal time comes you might find that the difference becomes quite extraordinary.

Are RRSP Accounts Worth It?

To answer this question, let's explore a simple example. To do this, we have to understand what capital gains tax is. Capital gains tax is the money you're taxed on investments that are in a non-registered investment account, or for simplicity sake in regards to this blog post, the money invested not in your RRSP account.

In Canada, we are charged a capital gains tax on half the profit of our sold investments. The tax amount is equivalent to the tax bracket we're currently in.

Now that we know that, let's look at the following side by side case:

Case 1:
$10,000 invested in an RRSP with a $2,000 refund invested in a non-registered account.
Versus
Case 2:
$10,000 invested in a non-registered account

For both cases let's assume a 12% year over year growth for 30 years:

Case 1:
$10,000 x 12% gain over 30 years = $299,599
$2,000 x 12% gain over 30 years = $59,919

Case 2:
$10,000 x 12% gain over 30 years = $299,599

Now we're not done yet, let's assume after 30 years we sell our investment and withdraw it. Let's also assume that we're in a 20% tax bracket at this time:

Case 1:
$299,599 - we cannot withdraw this entire amount all at once because it synthetically raises our tax bracket, so let's leave this for now.
$59,919 x 50% x 20% = $5,991 in taxes
= $53,927 remaining

Case 2:
$299,599 x 50% x 20% = $29,959 in taxes
= $269,640 remaining

Something you may not have seen coming happened above. In case 1 we were stuck because if we withdraw all of funds at once we will synthetically raise our tax bracket. As we saw at the start an RRSP synthetically raises our income, whereas a non-registered account does not. So let's look at three scenarios for Case 1, we'll call them Scenario A, B, and C.

Scenario A
We withdraw $20,000 every year for 15 years, and let's say we work less so our tax bracket drops to 15%.
So $299,599 x 15% = $44,939 in taxes over 15 years
= $254,659 remaining + $53,927 from our non-registered investment
= $308,586 grand total return, a cool $40,000 more than our Case 2 investment in strictly a non-registered account, however we only access our funds a little at a time over 15 years, maybe it's for the best!

Scenario B
We want to live a little, so we withdraw $60,000 every year for 5 years, and doing so raises our tax bracket to 25%.
So $299,599 x 25% = $74,899 in taxes over 5 years
= $224,699 remaining + $53,927 from our non-registered investment
= $278,626 grand total return, a decent $9,000 more than our Case 2 investment in strictly a non-registered account, and we can access a good portion of our funds every year for 5 years, sounds pretty good to me!

Scenario C
We hate restrictions, we we withdraw all $299,599 at once, and doing so raises our tax bracket to a whopping 33%
So $299,599 x 33% = $98,867 in taxes
= $200,731 remaining + $53,927 from our non-registered investment
= $254,658 grand total return, which is sadly -$15,000 less than our non-registered investment in Case 2! Oh boy.

So... Are They Worth It...?

Well that's a tricky question, and we did simplify a lot with our calculations above, however the simple calculations tell us something very important.

It Depends.

In most cases (2 of 3 in our examples) they are worth it, and they're a very good way to make sure you don't touch your investment until you don't have an income. However, if you're the type of person who will need to live lavishly in retirement or use your RRSP funds for emergencies when you're working full time, then stay away from them! It really is a case by case basis, but one thing that surprised me in doing the calculations is how the difference isn't very significant! It's definitely rewarding and a lot more rewarding if you're in a high income bracket. So I guess in my opinion, if you make a lot of money or believe you'll have a frugal retirement, then go for the RRSP! Otherwise, you might be better off in a non-registered account!

What have your experiences been like?

Are you a Canadian? If you're not then what kind of savings systems does your country give you?

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