PH&N’s take on the investments in a RRSP or outside debate

February 7, 2011


A few years back, money manager PH&N put out a report on whether investors should save inside a RRSP or outside. The report, titled, The Retirement Savings Debate: Inside or Outside the RRSP structure, took a closer look at some opinions that it is more efficient to save for retirement outside a registered plan with the federal government reducing the capital gains inclusion rate to 50 percent.

First, the report tackles who should not save inside a RRSP:

It does not make sense for an individual who has a perpetually low annual taxable income to contribute significant funds to an RRSP if their withdrawals in retirement will be taxed at a higher rate than their current tax rate. Such situations are rare, but may arise, for instance, if an individual with significant accumulated unused contribution room from having invested little in RRSPs receives an inheritance close to retirement.

Second, the report examined the after-tax value of savings inside a RRSP and outside for three different asset mixes. It finds that the more a portfolio is tilted towards bonds, the bigger the advantage of saving within a RRSP. The calculations were made for an individual with an annual income of $100,000. The report says that calculations were also done using an annual income of $40,000 and the results were similar but not as dramatic.

The PH&N report also points out a key qualitative benefit of RRSPs that are absent in other vehicles:

Withdrawals from RRSPs are taxed as income. Because of this, individuals who are still working are less tempted to dip into their retirement savings to fund a discretionary purchase.

The bottom line: If you are middle- or upper-income earner, saving for retirement using a RRSP is more beneficial than saving in a non-registered, taxable account. The advantage is even more tilted in favour of RRSPs if you choose to hold the fixed income portion within it.

Ranting against RRSPs

February 1, 2011


A recent column in The Financial Post (See Were RRSPs a major mistake?, FP, Jan. 19, 2011) by John Newell, a Toronto retiree, makes an amusing rant against RRSPs. The author makes one good point: it doesn’t make much sense for Canadians with little or no income to contribute to a RRSP, especially with the availability of Tax-Free Savings Accounts (TFSAs). But the rest of the arguments are either far-fetched or just plain wrong:

RRSPs have contributed to the growing gulf between low-and high-income families, which is not healthy for a democracy that needs a growing middle class to thrive.

Why stop there? Why not blame RRSPs for global warming, the Russians scoring five quick goals in the World Juniors or the Olympic torches malfunctioning in the Vancouver Olympics?

That leaves Canadian equities, but why on earth would one want them in an RRSP or RIF when one cannot take advantage of dividend tax credits or low rates of capital gains taxation?

Simple. If you are in anything but the lowest tax bracket, a RRSP allows you to (a) defer tax and (b) shelter portfolio earnings from tax. If your RRSP can accommodate the Canadian stock portion of a portfolio, then that’s where it belongs. Why pay taxes on dividends when you have the option of not doing so?

Don’t forget governments can change the rules of RRSPs (or unit trusts) at any time, especially when they claim they will not.

The Government may also change the rules of TFSAs, dividend tax credits or capital gains taxes. We cannot make plans based on what rules the Government may or may not do in the future.

Canadians are smarter than the government and the financial services industry give us credit for. That is why only 55% of Canadians have RRSPs and why we use about 6%of our total contribution space, leaving more than $600-billion of space unused.

If RRSPs are not such a problem after all, why rant against them? It is a bit hard to sympathize with some Canadians bitterly complaining about having too much in their RRSPs. The solution is simple: stop complaining about your taxes, retire early and enjoy your savings.