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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?

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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.

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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

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.

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

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.

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?

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.

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.

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).

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 – 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…