Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a beginning or experienced investor, these weekly updates are designed to give you specific investment advice. Each Investor Toolkit update gives you a fundamental piece of investing strategy, and shows you how you can put it into practice right away. Today’s tip: “You take a double loss if you lose money in your RRSP, which means that it is an expensive place to find out if you have a talent for stock trading.” Registered Retirement Savings Plans or RRSPs are a little like other investment accounts, except for their tax treatment. You can put up to 18% of the previous year’s earned income, maximum $23,820 for 2013, into an RRSP, and deduct it from your taxable income. (The limit is lower for pension plan members.) You only pay taxes on your RRSP investment, and the investment income it earns, when you make withdrawals from your RRSP. You might think of investment gains in an RRSP as a double profit. Instead of paying up to 50% of your profit to the government in taxes and keeping 50% to work for you, you keep 100% of your profit working for you, until you take it out. If you lose money in an RRSP, however, you have a double loss. You lose your money, and you lose the opportunity to have that money grow in a tax-deferred environment for years, if not decades, until you take it out. That’s why successful investors put only their safest investments in RRSPs. If they indulge in penny stocks, stock options or short-term trading, they do so outside their RRSPs. That way, they avoid the double loss. And they can use any losses they do suffer to offset taxable capital gains. [ofie_ad]
Inside and outside an RRSP—the worst-case scenario
As an example let’s contrast two outcomes for an investor in the 50% tax bracket who invests $10,000 in an RRSP, and $10,000 outside an RRSP. Here’s the result when the investment is placed within an RRSP. The amount invested earns 10% yearly and rises from $10,000 this year to $67,275 in 2033. After withdrawing the money and paying 50% tax at that time, the investor still has $33,637.50. Here’s what happens with the same investment outside an RRSP. The investor pays 50% tax to start on his $10,000, and invests the remaining $5,000 at 10% a year. Since he’s paying 50% taxes on the investment income every year, the value of his investment only grows to $13,265 by 2033 — only 39.4% of the after-tax $33,637.50 value of his RRSP investment. This is a “worst-case scenario”. It only applies to GIC or bond investments. Stocks and mutual funds enjoy some tax shelter outside an RRSP, since tax rates are lower on capital gains and dividends than on GIC interest. But the principle is the same. Your money grows faster if you put it in an RRSP, and pay taxes later rather than now. COMMENTS PLEASE—Share your investment knowledge and opinions with fellow TSINetwork.ca members Do you have distinct preferences for the kind of investments you hold inside an RRSP and those you would rather hold outside? Have you changed your thinking on your RRSP strategy over the years? Has the Tax-Free Savings Account changed the way you think about registered savings accounts? Let us know what you think.
