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Book Review: RRSP’s

If you follow any of the other Canadian personal finance blogs around, you would have read about the new and upcoming book written by Preet Banerjee called "RRSP's". 

For non-Canadian readers, RRSP stands for "Registered Retirement Savings Plan" which is basically an investment account for Canadians that allow investments within it to grow tax free (along with other perks).

Ok, lets get down to the book review. 

Who is Preet Banerjee? 

Some of you reading this will know Preet Banerjee as the blogger behind "WhereDoesAllMyMoneyGo".  What most people don't know is that Preet is a former amateur race car driver and a full time financial planner for high net worth clients.  What I think separates Preet from other financial advisors is that he's willing to give away sound financial strategies that don't benefit him directly. For example, there is a section in the book that shows that paying off the mortgage first can have benefits over contributing to an RRSP at the same time.

What is this book about?

This book starts off with explaining the basics of RRSP's and how to calculate your tax return based on your RRSP contribution.  From there, it moves onto 41 RRSP based strategies from basic to more complex. 

Even though i've done quite a bit of research on RRSP's, I have learned a few things from this book, especially with the detailed scenario comparisons.

What I liked about the book?

My favorite parts of the book where the chapters that involved scenario calculations.  In particular, the detailed numerical comparisons between:

  • Mortgage vs. RRSP and various combinations.
  • RRSP vs. Non-registered portfolio
  • RRSP Meltdown effectiveness and associated calculations
  • Traditional RRSP vs. Straight Leverage vs. Preet Principle

What did I learn the most from this book? 

I knew this before, but never really put into context HOW important it is. Always, ALWAYS use your RRSP tax refund efficiently.  Whether it's paying down debt, re-contributing to your RRSP, or putting it in a non-registered account, the overall benefit of the RRSP depends on it.

What needs improvement?

There is nothing in particular that I didn't like.  One little note though, at the beginning, it explains how to calculate your RRSP tax refund based on your salary and total taxes paid in.  Another way to calculate your tax refund is to  simply multiply your marginal tax rate by your total contributions.  For example, if you contributed $5,000 and you're in the 40% tax bracket, you should get back approximately $5,000 x 0.40 = $2000. 

Final Thoughts:

  • I highly recommend this book for all Canadians who want to understand RRSP's in depth.  It's a book that is easy to read for both the beginner and more advanced.

Stay tuned for tomorrows post.  Preet has been generous in offering MDJ a few copies to give away.

If you would like to read more articles like this, you can sign up for my free newsletter service below (we will not spam you).

FT About the author: FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 33 comments… add one }
  • The Reverend February 4, 2008, 10:15 am

    I’ve heard people say before that RRSPs are only beneficial if you use the tax refund appropriately (further investing or paying down debt). Does this take into the consideration the “benefits” of spending it frivolously, say on new golf clubs or something of the like?

    I know its not the wisest desicion but if non-registered and registered are more are less a wash in the long run, if you don’t reinvest, then at least you have the refund to spend. Maybe I’m oversimplifying, as I haven’t “run the numbers” myself.

    Note: I haven’t read Preet’s book.

    • FrugalTrader February 4, 2008, 10:26 am

      Revered, you are right, RRSP’s usually come out ahead (providing a higher tax bracket) when the tax refunds are re-invested. Preet does numerous calculations in his book of what happens when refunds are not re-invested and a non-reg portfolio can come out ahead in this case (under certain circumstances). Overall though, I think the point is that tax refunds “should” be reinvested to get the most out of RRSP’s.

  • Deborah February 4, 2008, 10:41 am

    I always figured the push to put money in a RRSP when you still have a mortgage was in the better interest of the banks rather than consumers. They make a spread off your money, you take in less and you pay more. You end up paying so much more in interest and for more years…

    I did a spreadsheet analysis of this and at the time with tax refund and future tax liability I calculated the RRSP had to make about 5% to break even. I wasn’t crazy about the idea of putting money into an RRSP instead of on the mortgage, but it was 2 to 1, hubby and mother-in-law versus me. I actually managed to divert $5k to the mortgage in a compromise…

    Well, the RRSPs were in stocks, purchased right before a crash and they lost 1/3rd. At the time, we had about the same in RRSPs as we had in home equity, so over all it was about a 16-17% loss of total wealth between one statement and the next. And each dollar that could have gone to the mortgage would have saved about $1 of interest over the life of the mortgage…

    And the thing is, no one knows what tax rates will be when you go to take the money out of a RRSP. My bet is they will be higher than today. They can’t possibly remain where they are with our social program commitments and I can’t see the social program commitments being reduced enough to prevent taxes from going up. There will probably be a reduction of social programs in combination with tax increases to balance it out. I doubt the age exemption will exist by the time I retire. It means that everyone’s accounting on how well they actually end up doing on their RRSPs is probably over stated.

    I’ve decided against putting anymore money in my RRSP at this time in favour of just paying the taxes now. If tax rates go up I may go back to making deposits, but right now I don’t think tax rates are sustainable in terms of what has been promised. Without working out numbers I suppose I need to be in a 50% tax bracket before I think the RRSP thing works in terms of where I think taxes are going.

  • FrugalTrader February 4, 2008, 11:17 am

    Deborah, thanks for the detailed comment. As mentioned above, RRSP’s are a better option than paying down the mortgage in the scenario where the refunds are reinvested AND the rate of return on the RRSP is higher than the mortgage.

    However, Preet has shown that by making a conservative assumption on market returns, you may come out ahead by paying down the mortgage first, then aggressively contributing to your RRSP with the old mortgage payment (reinvested tax refunds ofcourse).

    You are also right in the fact that we don’t know where the tax brackets will be in 20-30 years. They could very well be higher than they are today, which would decrease the effectiveness of the RRSP strategy altogether.

  • FourPillars February 4, 2008, 11:59 am

    The only way to compare rrsps to non-reg is to assume the refund is contributed to the rrsp. To do otherwise is to compare apples and oranges since the money in a rrsp is pre-tax and the money in a non-reg is after tax.

    Even better, I always think of it in terms of gross income for the rrsp.

    Ie assuming a 40% tax rate, $1000 of gross income contributed to an rrsp is equal to $600 (after tax) outside an rrsp.

    Deborah – I’m a huge fan of paying down debt but your comparison of a short term equity loss vs long term interest savings is not valid. You have to use the same time frame.

    Also – don’t give up on the rrsp – it’s hard to lose with an rrsp unless you are in a low tax bracket. It doesn’t have to be one or the other – nothing wrong with concentrating on the mortgage now but consider at least small rrsp contributions at some point.

    I also don’t agree with your predictions of future tax increases to pay for our social programs. Given that the government has been running a surplus for several years I don’t think it’s unreasonable to think that the tax structure won’t change dramatically in the next 20-30 years.

    Mike

  • nobleea February 4, 2008, 12:19 pm

    As FP points out above:
    “$1000 of gross income contributed to an rrsp is equal to $600 (after tax) outside an rrsp.”

    a non-reg portfolio needs to gain over 50% off the bat to be square with the rrsp. if they funds are invested in the same things (ETF index funds or stocks) then they’ll grow the same % over time (perhaps with some tax due on distributions in the non-reg acct). of course, you have to pay tax on the withdrawals from rrsp when you retire. but as has been mentioned often before, you are taxed from the lowest bracket upwards when withdrawing from the rrsp, but you get a tax refund from the top bracket down when you contribute.
    as long as you don’t spend the tax refund frivolously, rrsps should always come out ahead.

    • FrugalTrader February 4, 2008, 1:59 pm

      In Preets book, he does a comparison between investing in non-registered portfolios and registered with productive use of refunds. In the end, the results were pretty close. Mind you, the investor had to pay the non-reg annual taxes out of pocket which can be substantial depending on the investments.

  • Daniel M, February 4, 2008, 11:14 pm

    I was investing 8% of our annual income into RRSP’s in the past years and using the refunds to round out the year and make sure we did not carry any high interest debt.

    After changing financial planners we implemented the Smith Manoeuvre and now the 8% and the tax refunds go towards paying down the mortgage and re borrowing every dollar to invest in mutual funds and ETF’s. We will be done paying for our mortgage in 8 years instead of 21 years at which point the 8% and tax refunds will go into RRSP’s.

    Both scenarios allow us to save 8% of our income and get nice tax returns.

  • nyari duit di internet February 5, 2008, 4:56 am

    hmmm…that’s a nice book…
    great info inside here

  • Dividendgrowth February 5, 2008, 12:28 pm

    I have a question about canadian RRSP’s. At what age can you start taking out your contributions? I do believe that it’s a great idea to have your future pension in a tax defered account, which can grow tax free forever. But, what if you want to retire at 40 or 45 for example? Would this plan allow you to?

  • Ann February 5, 2008, 2:42 pm

    I am wandering if I should continue contributing to my RRSP as I have taken early retirement and on a very low pension and had a high salary when I did contribute as I read above something about it being not so effective when your income is low. I do have the $2000 overcontribution to use yet as well but not sure what to do for this year.

  • Ben February 5, 2008, 2:44 pm

    Hi folks,

    I have decided to take the plunge and start investing into RRSP through my bank(RBC). When doing some research into self directed investing I stumbled up a new product called Series D mutual Funds. Series D funds ‘reward’ self-directed investors who feel comfortable doing their own research by reducing the MER and management fees normally charged for investing into the exact same funds. There are some drawbacks; min 10K initial investment per fund and a very limited array of funds (although most of the popular 5 star RBC funds are there).

    Here is a link

    https://www.rbcdirectinvesting.com/RBC:R6imGo71A8cAFSAWBwI/seriesd/index.html

  • George February 5, 2008, 9:31 pm

    Preet’s got a good handle on RRSPs… I wonder if he’s planning a follow-up title that talks about pensions and government benefits. RRSPs are, after all, only one part of anybody’s retirement income.

  • WhereDoesAllMyMoneyGo.com February 5, 2008, 11:30 pm

    FT – Sorry, I’ve been pre-occupied lately… but thanks for the review! :)

    George – that’s a great idea, I’ll add it to my list of books to write (I have two more in mind, late ’08 and ’09 release dates). But I think that would be a great subject…

  • Gates VP February 6, 2008, 1:08 am

    DividendGrowth: You can take the money out of RRSPs at any time, it’s your money. However, you have a contribution limit and you’re taxed on that money when you withdraw (b/c you got it tax-free on the way in). You’re basically taxed on the withdrawal as if it were income.

    The government lets you contribute ~18% of your salary / year towards your RRSP, but that number rolls over from year to year. If you’re like most people who haven’t contributed in years, you likely have tens of thousands in available contribution room, so you’re unlikely to use it up.

    Deborah:And each dollar that could have gone to the mortgage would have saved about $1 of interest over the life of the mortgage…

    You ignited some discussion with this comment, but you’re missing something very fundamental here. If you have 20 years left in your mortgage, you’re effectively saving the last dollar of interest for every extra dollar that you pay down. You’re basically paying one dollar today to save another dollar in 2028.

    But that dollar in 2028 is worth a whole bunch less. At a steady 3% inflation, that 2028 dollar has an equivalent purchasing power of about 56 cents. If you invest the dollar and it grows faster than 3% over the course of 20 years you end up ahead.

    Of course, if you only have a few years left, then the math works differently.

    We conveniently ignore inflation all of the time. But when it comes to mortgages and retirement, the inflation factor is a big deal. Personally, I’d try to think about it in terms of “annual salaries” saved.

  • George February 6, 2008, 2:11 am

    Just a follow-up to GatesVP’s comment regarding withdrawals from RRSPs – it’s true that you can withdraw the money at any time, but there are some huge drawbacks to early withdrawals:

    1) Taxes are withheld by the RRSP provider before you even get the money.
    2) Once the money is withdrawn, it can’t be put back in unless you still have contribution room. If your current contribution limit is $1000 and you withdraw $2000 from your RRSP, the most you’re able to put back in is $1000 (until you file your next tax return, and get more contribution room).

  • George February 6, 2008, 2:20 am

    GatesVP: Your explanation of mortgage interest doesn’t make sense. If you prepay a dollar on your mortgage today, and you’ve got another 20 years to pay off the mortgage, then you’re saving interest costs on that $1 each and every day between now and when you pay off the mortgage, meaning that the “fully paid off” date will be much sooner.

    By making some fairly minimal prepayments on our mortgage, we’ve turned our 25 year mortgage into a 15 year mortgage (maybe less). There’s something really liberating about the thought of having a mortgage paid off in full by age 40.

    The “mortgage vs. RRSP” debate doesn’t really apply to me, since both myself and my wife have already reached our RRSP contribution limits. Our debate is between prepaying the mortgage and investing in a non-registered portfolio – my preference is to get rid of the mortgage ASAP, and then pour the cash into the non-registered investments.

  • George February 6, 2008, 2:23 am

    Ann writes: “I am wandering if I should continue contributing to my RRSP as I have taken early retirement and on a very low pension and had a high salary when I did contribute as I read above something about it being not so effective when your income is low. I do have the $2000 overcontribution to use yet as well but not sure what to do for this year.”

    If you’ve taken early retirement, and can live entirely off of the pension, it makes sense to do that. How are you going to contribute to an RRSP if you don’t have the disposable cash?

    Contributions to an RRSP don’t make as much sense if your income is low and you’ll be using the income in the near future, since you lose the advantage of the tax savings, and don’t get that much of a benefit from the tax-free growth on your contributions.

    Ideally, you’ll contribute heavily to an RRSP during your peak earnings years, and withdraw from the RRSP when you’re in a much lower tax bracket. Things don’t always work out that way, though.

  • nobleea February 6, 2008, 2:31 am

    Am I correct in assuming that your rrsp contribution room for 2007 tax year is whatever is listed on your 2006 tax statement plus 18% of your 2007 net income? So that the contribution room is not a year delayed?

    Does anyone know what happens if you overcontribute a significant amount on March 1 and then take it out Feb 28 the following year (to get back under your contribution limit) – any gains built up over the year in the rrsp – what happens to them? Does it stay in the rrsp tax free?

    Am I also correct in assuming that no one tells you how much you can contribute during the year, it is only at tax time that CRA makes sure you haven’t gone over your contribution limit?

  • George February 6, 2008, 9:46 am

    Noblea: You’re correct about the contribution room, but there are a few provisos. If you have a pension, then your contribution limit is reduced by a “pension adjustment”. The better the pension, the higher the pension adjustment. The idea is that people with pensions are already getting tax-deferred retirement savings, and allowing them the same amount of RRSP room as people without pensions would put give them an unfair advantage with regard to their taxes.

    If you overcontribute on March 1st, then it’d show up when you get your tax slips for the following year, and would have to be reported on that year’s tax return. When you withdrew the money on February 28th, tax would be withheld immediately and the full amount withdrawn would be added to your taxable income for the year of the withdrawal. Sure, any gains could stay in the plan, but it seems like a poor use of your contribution room, since you’d only get tax-sheltered gains for a single year.

    You’re quite correct in that nobody tells you how much you can contribute during the year – it’s not your bank, brokerage, or other RRSP provider’s responsibility to keep track of your contribution limit (in reality, they have no way of knowing what your limit actually is). When you file your taxes, you have to report the contributions. You don’t need to take the deduction in the year that you make the contribution, but you still need to report the amount you’ve contributed. Overcontributions beyond the $2000 “buffer” are subject to penalty taxes until they’re withdrawn.

  • nobleea February 6, 2008, 12:51 pm

    but it wouldn’t affect your contribution room if it was over? i mean as an alternative to investing in a non-reg account if you’re already maxed out on your contribution room. put in 100K in to the rrsp on march 1. you do not get a tax deduction. take it out on feb 28. sure they withhold the tax, but once your income tax is filed you get it back since there’s no net gain (a couple weeks later). over that year, the 100K generates interest, dividends or capital gains that will be tax free and allowed to stay in the rrsp. i don’t know how many years you could repeat the process before CRA started getting annoyed.

    There is a monthly penalty tax, but that appears to kick in only after you mention the overcontribution to CRA (the next tax year)

  • Ann February 6, 2008, 6:31 pm

    So ….should I only use my overcontribution amount of $2000 for this first year on a low income pension and keep any savings at hand for emergency use instead of adding it to my RRSP?

  • George February 6, 2008, 8:11 pm

    Ann: If you are on a “low income pension”, why are you even thinking about making an RRSP contribution? If you’re now retired and drawing income from a pension, it probably makes sense to think about withdrawing funds from the RRSP instead of putting more money in – retirement income is, after all, the very purpose of an RRSP. But, that’s just my thought – take it for what it’s worth.

    If you need specific advice tailored to your situation, though, it’d be a better idea to talk to a professional rather than a bunch of people posting comments on a blog. You’ll get a far better, more personalized response that way.

  • FrugalTrader February 6, 2008, 9:02 pm

    Ann, i’m with George on this one. If you are living on a low income pension, then RRSP contributions shouldn’t even be considered IMO.

  • Acorn February 13, 2008, 4:44 pm

    I’m just wondering what this book says about RRSP Meltdown effectiveness.
    Can we combine RRSP meltdown with SM somehow?

  • Four Pillars February 13, 2008, 11:05 pm

    Acorn – he does talk about meltdown strategies including using leveraged investments to offset the tax burden.

    From what I recall he doesn’t really advocate them because you have to borrow a lot of money to make it work which isn’t all that realistic for most people who are near or at retirement age.

    Mike

  • Kevin February 21, 2008, 5:28 am

    I would just like to give an example of how well an RRSP will work as far as your return on investment within only a couple of years. This example is based on a 40% tax bracket and purchasing $10,000 per year based on a 4% annual return and re-investing your tax refund into the next years RRSP contribution. I know ING offers at least a 4% annual return at this time

    Yr 1 money contributed-$10,000 refund bonus-$4000.00
    Yr 2 contribution -$10,000 refund bonus-$4000.00
    Yr 3 contribution -$10,000 refund bonus-4000.00 Yr 4 re-investment of last bonus-$4000

    Now if you notice it appears that you have invested $34,000 into your RRSP but if you consider that you have re-invested all of your bonus income from your tax return in essence your out of pocket investment is as follows

    year 1 $10,000
    Year 2 $6,000 (+ $4000.00 Refund)
    Year 3 $6,000 (+ $4000.00 Refund)
    Year 4 $0 (+ $4000.00 Refund)
    Total out of pocket Contribution $22,000

    (total actual Contribution $34,000)

    Now, by the end of year 5 after only contributing $22,000 dollars out of your out of pocket cash and compounding 4% annual interest on your RRSP investment, you now have an RRSP valued at $37923.23

    This means after 5 yrs, you are ahead $15,923.23 but obviously you do not need to take out the RRSP, just let it grow and compund interest now and you will begin making 1,516.92 per year (based on 4% annual)and rising without contributing any more.

    Now I know when you take out the RRSP you will be taxed, but if you decide to take it out before you retire and you take it out on a low income year than you will pay less tax than you ultimately saved on your refunds.

    If there is anyone out ther to correct my math, or my positivity on using RRSP’s to the fullest please let me know.

    Otherwise, I hope this math and example helps out a few people in making a choice in where to invest your money.

  • Rachel February 29, 2008, 2:14 pm

    I’m new to RRSPs, Kevin, but I understand your calculations. :)

    I have a question for you. You calculated an RRSP with a constant rate of 4%. What if I start a 5-year RRSP (GIC), with an increasing rate each year, and after the 5 years I want to keep the money in the RRSP. Does the rate stay at the highest (ie. year 5), or does it drop back to year 1?

  • George February 29, 2008, 11:01 pm

    Rachel: That’s a question you should direct to the issuer of the GIC (i.e. your bank). What happens to the GIC upon maturity is not relevant to whether the GIC is held within an RRSP or not.

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