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Maxing Out Your RSP is More Important than Ever

Give the Trudeau government credit for honesty. It has been consistent and open about its plans to tax the rich. Nobody should have been surprised by the recent tax policy initiatives aimed particularly at professionals. In Trudeau’s world, anyone making more than $150,000/year should be taxed more. Sloppy messaging by Bill Morneau, coupled with his personal lapses (Chateau? What chateau? Oh, that one, in France!) have resulted in a small pull-back in the extent of the tax grab, but make no mistake: High earners are locked in the sights of the CRA and policy makers, and will not escape. Frankly, there are many, many more votes to be gained in the middle class.

Given this reality, what is the high-income earner to do? There are very few legitimate tax shelters left in Canada. Hiding money off-shore is illegal and the international anti-money laundering police have sharp teeth and long arms. Even the Americans, for all of their friendliness to rich people in general, have made life more difficult for Canadians with the Foreign Account Tax Compliance Act (FATCA) and computerized border controls that count days of residence in the US. Not working might be an option for some, and marginal tax rates over 53% will certainly encourage some of our older clients to call it a day. However, for most of us, that is not (yet) an option.  One of the few tools still left is the venerable, somewhat unloved and sometimes overlooked Registered Retirement Savings Plan (”RSP”).

A tax deferred is a tax saved. This is the primary virtue of the RSP. It does not eliminate taxes, but it shifts them from now, when they are at maximum levels for high earners, to the future, when they might be at lower rates. In addition, an RSP allows the taxpayer to invest pre-tax money rather than post-tax money, thus more than doubling the amount upon which investment income can be earned. Finally, with the degradation of the dividend tax credit over the past ten years and the taxation of interest earnings at the highest tax rate (over 52% in Ontario) the opportunity to compound investment earnings tax free inside of an RSP for an extended period is a substantial benefit.

The math is compelling. A $25,000 RSP contribution today will be worth almost $100,000 in 20 years (assuming a 7% rate of return). The after-tax equivalent of $25,000, $12,000, invested outside of an RSP, with investment income subject to tax, would grow to only $26,000 over the same period. Make that $25,000 investment every year for 20 years, and the difference becomes enormous. The RSP would have a value of about $1.1 million, compared to $363,000 for the fully taxed account.

We have seen this reality at work, and a considerable number of our clients have RSP accounts worth more than $2 million. The money does have to be taken out starting at age 72, but thanks to the last Conservative government, it can now be withdrawn at a slower pace, and fully divided between spouses to reduce the tax burden. Given the reduced opportunity for splitting (or “sprinkling”) of current income from companies under the anticipated new rules, it is better to split later than not at all.

We are often asked by clients if they should first invest in an RSP or a TFSA. For income earners in the highest bracket, an RSP is the better option. The low amount that can be contributed to a TFSA and the inability to defer current income tax when making a TFSA investment make it a distant second choice. For those with enough disposable income, the best decision is to use both.

For small business owners, self-employed professionals and most non-governmental workers, no one will be responsible for their well-being in retirement except themselves. The days of guaranteed defined-benefit pension plans are pretty much gone except for civil servants and a few unionized industries. The rest of us need to take care of ourselves. The RSP is the best way to do it. Contribute early, contribute often, and utilize the unused contribution room shown on your income tax assessment. Time is your greatest ally and delay your greatest enemy.