Agenda:
Lesson 4: Retirement Savings
We will discuss the merits of RRSP’s (Registered Retirement Savings Plans) and TFSA’s (Tax Free Savings Accounts). This is relative to Canada only, but the concepts may apply in your country of origin.
Lesson 4 – Conclusion, & Basic Investments
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Now, a comment about Retirement Savings:
RRSP’s: It is a general assumption that everybody should have an RRSP. This is NOT true. Some people who are in a low Income Bracket may feel guilty and anxious because they cannot afford to contribute to an RRSP. They worry that they may not be prepared for Retirement, let alone managing their responsibilities today.
Low Income people should NOT be investing in RRSP’s. Anybody who does invest in an RRSP, needs to know what the Benefit is. The following examples uses approximate figures for the sake of simplicity, but you will get the concept.
If a man is in a high Income Tax Bracket, say 40%, which means for every $100 he makes, he pays $40 in Taxes, be will benefit with an RRSP. When he puts $100 in an RRSP, he does not pay Tax on it, (this is called Tax Deferment) and he won’t pay tax on it until he withdraws, presumably when he Retires. It is assumed when he retires, he will be in a low Income Tax Bracket, like 20%. SO when he withdraws the $100, he will pay $20 Tax. The benefit of the RRSP is that he has saved $20 Tax on every $100 placed into it. That is a significant savings.
Like wise, a person in a middle Income Tax Bracket, say 30%, will defer $30, then pay $20 when he withdraws the money at retirement, thereby saving $10 Tax on every $100 in the RRSP. Again a measurable savings.
A low income person in a 20% Tax Bracket would only save $20, but then pay $20 when he withdraws the money, so there is no benefit. In fact there would be a penalty. Let me explain.
When you retire, you will collect Canada Pension Plan (CPP) benefits, and Old Age Security (OAS) benefits. The amount will depend on how much you contributed to CPP over the years, but the maximum combined amount is around $1500 per month. If a person is under a certain threshold amount, they will be entitled to an Income Supplement. If you are entitled to the Supplement, then every dollar you withdraw from an RRSP (when it puts you over the threshold) will reduce your supplement by 50 cents. But then you still have to pay the tax on the RRSP withdrawal.
A person in this situation would be better to invest in a Tax Free Savings Account (TFSA). Any contributions made in a TFSA is not Tax Deferred, so you would have to pay the tax on it the year you earn it, but that money and any interest earnings is Tax Free when it is withdrawn, and it is not counted towards the Income Supplement threshold.
Another interesting fact about Taxes that one should be aware of is in the case of early retirement.
If you choose to start collecting your CPP before you are 65 years old, your pension will be reduced by 0.5% per month. This means that if you opt to start collecting when you are 60 years old, which is 60 months from 65, then your CPP will be reduced by 30% for life.
[NOTE: the numbers used for early retirement above are out of date, and percentages have now increased.]