Your investments gain doubly in your Registered Retirement Savings Plans (RRSPs), but if you lose, you take a double loss, so don’t use your RRSP as a place to find out if you have a talent for stock trading. Here’s how to make RRSPs a double win rather than a double loss.
RRSPs are a little like other investment accounts, except for their tax treatment. You can put up to 18% of the previous year’s earned income, maximum $24,930 for 2015, into an RRSP, and deduct it from your taxable income. (The limit is lower for pension plan members.) You pay taxes on your RRSP investment, and the investment income it earns, only when you make withdrawals from your RRSP.
You might think of investment gains in an RRSP as a double profit. Instead of paying up to 50% of your profit to the government in taxes and keeping 50% to work for you, you keep 100% of your profit working for you, until you take it out.
If you lose money in an RRSP, however, you have a double loss. You lose your money, and you lose the opportunity to have that money grow in a tax-deferred environment for years, if not decades, until you take it out.
That’s why successful investors put only their safest investments in RRSPs. If they indulge in penny stocks, stock options, or short-term trading, they do so outside their RRSPs. That way, they avoid the double loss. And they can use any losses they do suffer to offset taxable capital gains.
Inside and outside an RRSP: the worst-case scenario
As an example let’s contrast two outcomes for an investor in the 50% tax bracket who invests $10,000 in an RRSP and $10,000 outside an RRSP.
Here’s the result when the investment is placed within an RRSP. The amount invested earns 10% yearly and rises from $10,000 this year to $67,275 in 2033. After withdrawing the money and paying 50% tax at that time, the investor still has $33,637.50.
Here’s what happens with the same investment outside an RRSP. The investor pays 50% tax to start on his $10,000, and invests the remaining $5,000 at 10% a year. Since he’s paying 50% taxes on the investment income every year, the value of his investment grows to only $13,265 by 2033 – only 39.4% of the after-tax $33,637.50 value of his RRSP investment.
This is a “worst-case scenario”. It applies only to GIC or bond investments. Stocks and mutual funds enjoy some tax shelter outside an RRSP, since tax rates are lower on capital gains and dividends than on GIC interest. But the principle is the same. Your money grows faster if you put it in an RRSP, and pay taxes later rather than now.
This post originally appeared on TSI Network, © 2015 TSI Network.
Patrick McKeough, host of the TSINetwork.ca investment website, has been a professional investment analyst for more than three decades. He is also a portfolio manager and the editor and publisher of four investment advisories: The Successful Investor, Wall Street Stock Forecaster, Stock Pickers Digest, and Canadian Wealth Advisor. Follow Pat on Twitter and Facebook.
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