An RSP Present for Christmas

 In Value For Money Investing

My Christmas gift this year is for those who are working and earning less than $36,848 per year (2009) or, in other words, find themselves in the lowest marginal tax bracket. My gift comes in the form of me telling you something that you are not hearing anywhere else. I want to be clear from the outset though; you need to save each and every year. The question being poised in this article is where is the best place to save, not if.

January is just around the corner and we will soon see the march of advertisement after advertisement for RSP contributions. I find that there is something missing from all those ads. They imply that ALL Canadians should contribute to their RSPs. This is simply NOT TRUE. RSPs are a tax advantaged method of saving for sure, but you have to have the tax situation that triggers the advantages. Canadians in the lowest tax bracket simply do not have the same advantages of other Canadians at the higher tax brackets. In fact, for those in the highest of tax brackets, RSPs are still probably the best method of reducing your lifetime tax bill. For those of you in the lowest of tax brackets, they are not as good and potentially a wealth reducer.

How can that be? Well, I will spare you the math, but think of it logically. As you save into your RSP you are lowering your tax bill by approximately 20%* of the amount you deposit; in other words, CRA will send you an increased refund or reduce what you have to send them. You are 20% richer of the deposit for now. In fact, when you consider that you can also deposit the refunds into the RSP, you will actually increase your wealth by 25%. (You can see all of the math on our website at When it comes time to withdraw from your RSP, you will pay tax on the withdrawals. The taxes you saved originally will also be compounded and will be sufficient to pay the tax on withdrawal if you are still at the same tax rate.

Therefore, the BEST net effect is that whatever you have put in will have compounded as if it was tax free. When judged in comparison to fully taxable investments such as GICs, this is a very good thing. In short, if you put the money into the RSP and take it out while at the same marginal tax rate, your result will be the same as compounding in a tax free environment. That is the advantage and it remains true at all marginal rates if they are the same going in as when coming out.

However, when you contribute at the lowest rate, you therefore know the MAXIMUM possible advantage: tax free compounding. When someone contributes at the highest marginal rate, their maximum advantage is not in removing it at the same rate, (this is the same advantage as you) but possibly removing it from the RSP at a much lower rate when no longer working. Their after tax withdrawal will be as much as 45% greater than yours. So, for higher earners, their advantage at worst case is the same as yours, at best case 145% of yours. They should fill their RSPs. Not so certain for you.

So what is wrong with a result equal to tax free compounding? Nothing at all, but you must examine what can go wrong. Foremost is the possibility that your withdrawals will be at a higher tax rate than when you contributed. Remember, if you contributed at the lowest rate, your only two possibilities are to be in the same marginal tax rate in the future or to be at a higher rate. A lower rate in future is not a possibility. Well, that is OK you are thinking, I obviously will be at the same rate in the future!!! Then you go and die. Unfortunately, if you pass away with funds still in your RSP or RIF (and almost every tax return I have ever prepared for a deceased individual had some still in there), you could find yourself with the situation that you put money into your RSP at the lowest rate and it is taxed at death at the highest rate. This high rate of tax is a common occurrence on the death of the surviving spouse, in a household where RSPs were built. Now, I do not want to overstate this as a problem, since it will only usually be on part of your contributions, not all of them. This is just the easiest problem to highlight quickly. What are some others?

Many individuals with career earnings at or below the first marginal tax rate will often qualify for Guaranteed Income Supplements after age 65. Withdrawals from your registered accounts will reduce your supplements by $0.50 for every dollar withdrawn. This can be like an effective tax rate of over 70%. Surely, we do not need the math to see the problem with 20% refund into a RSP versus 70% on the way out.

Now, that is enough on the possible problems. There are more and the lesson here is simply that MY SITUATION IS UNIQUE and I need to do some financial planning to determine if RSPs are right for me. Do not blindly follow the mutual fund pied piper during RSP season.

Some alternatives.

Your mortgage or credit cards. You will possibly receive a greater rate of return with the same tax free compounding. Paying down your debt will make you wealthier than having an RSP.

Tax free savings accounts – TFSAs – were introduced in 2009. They assure you of the same tax free compounding achieved with RSP contributions at the lowest rate, with none of the disadvantages noted above. A change to them is likely warranted for many.

Registered Education Savings Plans – RESPs – CRA will send you no tax refund, but you will be given a Canada Education Savings Grant on the first $2500 of 40% if FAMILY income is below $38,832 (30% until $77,664 FI and 20% thereafter).

So, as always, they key to making good decisions about your finances is preparing a financial plan that recognizes you and your family’s uniqueness. Bang your own drum and drown out the pied piper.


A final note! Christmas is almost upon us and the stock markets around the world continue to deliver gift after gift. This hopefully will continue right through Christmas and the New Year. A word of caution though, what goes up ALWAYS comes down, even Santa’s sleigh. Now on to it, on to it…

Merry Christmas!


* The 2009 lowest marginal rate for Ontario is actually 21.05%. We have used 20% for ease of illustration. The conclusions remain unchanged.

Value For Money Investing means we wish to allocate and use our hard-earned resources in order to improve investment outcomes in a continuous and sustainable way at a fair and equitable price. In other words, achieve good investment returns AND receive fair value for the services provided. Costs do matter!

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