RRSP Contribution
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I just made my final RRSP contribution for the year. For my US readers, and the definition of an RRSP can be found here – think of it kinda like a 401K.
My plan is to invest this money into more General Electric stock. This will bring my investment in this stock more in line with my other stocks and of course I still like the fundamentals.
There is a debate in Canada that pops up every once in awhile concerning the use of RRSP. One side believes that investing in an RRSP is not prudent because essentially all one is doing is deferring taxes to a later date, at which time they will be taxed to the full extent possible by the government when the money is withdrawn. The other side believes that the tax savings and refund that you (potentially) will receive from the government is more than worth the risk of increased taxes later on.
For myself, I am not sure which side I am on, so I do both. I have both an RRSP and non-RRSP account and fund both. This way I think I cover my bases – I get the refund, defer the taxes, and have money outside the RRSP to draw on when it is needed.
4 Comments on this post
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Investorial said:
Why are you investing individual stocks within an RSP? You cannot get the advantage of capital gain taxation that individual stock investing allows you to have. Such a venture would be better if left outside of your RSP account. If you follow an asset allocation strategy, invest your interest bearing securities in the RSP while keeping capital-gain producing securities outside.
I wouldn’t mind hearing your rationale behind this decision.
March 2nd, 2006 at 11:31 pm -
The Dividend Guy said:
The reason is simple…I don’t hold too many interest bearing investments. I am relatively young and therefore try to reduce my exposure to bonds etc. If I did invest in bonds or bond funds, yes I would definately put them in my RRSP. In terms of only investing individual stock outside of an RRSP – I don’t think that one has to only do that. I invest in an RRSP to get the tax deductions and tax deferal.
March 3rd, 2006 at 7:21 pm -
Daniel said:
1. You do have some fixed income. Put that in your RRSP, or else pay your mortgage instead.
2. After fixed-income, you should definitely max out your RRSP with your US equities even if you retire at a higher tax rate.
Let’s do an example. Suppose that:
1. Your US stock grows at 8% of which
2. 5% is capital gains and
3. 3% is dividend
4. Your tax rate right now is 30%.
5. Your tax rate when you retire is 40%.(a) Let’s invest $1000 pre-tax outside an RRSP. That means that after tax you have $1000 x 70% = $700 to invest. US dividends are taxed as regular income (unlike Canadian dividends) so you only get 3% x 70% = 2.1% for dividends. So your effective rate is 7.1%. After 30 years it’s grown to $5480 of which $2325 is capital gains. Now you pay capital gains tax on that:
$2325 x 50% x 40% = $465
So you are left with $5015.
(b) Now invest the same in an RRSP.
You invest the $1000 pre-tax at 8%. So in 30 years it grows to $10,062 but now you have to pay 40% tax on the full amount. So your tax is:
$10,062 x 40% = $4,025
Undoubtedly high, but you are left with $6,038.
In other words, you are better off by $1,023 inside the RRSP even if you cash out the entire RRSP at once at a 40% tax rate.
But there’s no reason why you have to cash out the RRSP. You can transfer the money to an RRIF to continue receiving tax-deferred growth longer.
If your tax rate when you retire is not higher, the math becomes much more compelling. And in the case of fixed income, the math is MUCH MUCH more compelling.
August 14th, 2007 at 4:38 am
[...] I haven’t gone off the deep end yet. Investorial is not a Blog about my own portfolio. I also don’t share the propensity to divulge my investment practices as other bloggers do. But I did enjoy reading The Dividend Guy and Investing Intelligently provide updates about their portfolio decisions. [...]