In 2008, the median amount of tax paid by families was $8,800 on a median net income of $63,900. That means the median RRSP contribution room was approximately $15,480. So what was the actual mean contribution? Just $2,680. We contributed about 17% of what we could have and paid far more in tax than we should have.
An RRSP is still the single best way for Canadians to minimize the amount of tax they are paying on their incomes. There’s a lot of blah, blah, blah about all the tax you’ll have to pay when you take the income out of the RRSP; the noise is a distraction from the bird in the hand.
If you’re earning enough money to qualify for a $15,000 contribution in Ontario, your marginal tax rate is 43.41%. That’s right, on that last dollar you earned, you paid 43.41 cents in income tax. How can that be a good thing?
Put that $15,000 contribution away in an RRSP and you’ll get back about $6,500 from the tax-man, more than enough to make your TFSA contribution. Or you could use that $6,500 to make a mortgage prepayment. That’d save you over $14,000 in interest on a $350,000 mortgage amortized for 25 years at 5%. Yup, $14,000. Do it every year and you’ll not only save almost $93,000 in interest, you’ll knock eight years off your mortgage. Holy moley macaroni! $93,000 less in interest! Mortgage free eight years sooner!
If you’re negating the value of an RRSP because tax eventually has to be paid on the money you pull out, you’re only looking at half the story. You’re not calculating the good you can do with those tax savings right now. How can it be bad to save for the future and get your biggest debt paid off faster and cheaper?
You can’t simply do a comparison between an RRSP and a TFSA based on return. You’ve got to also look at what you can do with the RRSP tax savings to increase your assets or reduce your debt. If you’re young, expect your income to increase over time. If you are already above the first two tax tiers in your province, an RRSP makes total sense. Just make sure you’re using the tax savings in a way that improves your quality of life now and in the future.