The Franz Group serves investors as part of
MacDougall, MacDougall & MacTier Inc.

Often we’re asked for our opinion. Take for instance, the theoretical case of Steve and Rhonda. They are questioning their investment strategies, or rather, their friends are. Although they’ve have been investing religiously for years and feel confident that they have their money in the right places, they often receive investment advice from friends that leaves them wondering if they are in fact doing all the right things.

While sipping on coffees after a casual supper with their friends, Jeff and Lisa, (not their real names) the conversation turns to retirement dreams and savings. “Why do you invest in RRSPs?” Jeff questions, “There is no point. Whether you get taxed now or later, you’re going to get taxed. I personally would rather pay the taxes now, before I retire, rather than wait until I’m making less money to be taxed on it. It just doesn’t make any sense to me to pay later.”

Steve and Rhonda are hoping to retire in the next 2 years, and while 2 of their children are out of the house, they still have their youngest at home. They feel that they have planned well enough that they will be able to retire comfortably regardless of whether they are still supporting their son while he completes his bachelor’s degree.

“We had the same concern when we first started investing,” Rhonda responded, “but when we spoke to our money manager, she really made some great points that convinced us that having some of our savings in RRSPs was the right way to go.” She continued, “The fact that you are not taxed annually when you put money into your RRSP means that you can actually earn more, despite having to pay taxes later when you withdraw the money.”

Jeff gives her a doubtful look, but Rhonda presses on, “Look, besides the fact that you increase your tax refund and are able to reinvest it, the portion of the investment return that would have been paid in taxes is actually being compounded and is therefore earning more than if you had invested it outside of an RRSP.” Now both Jeff and Lisa look perplexed.

“The easiest way to explain this is with an example,” suggests Steve, “say I invest $15,000 in an RRSP and you invest $15,000 outside of one. Let’s assume we each earn 8% per year on our investments, and are living in Quebec, since we are in the highest marginal tax bracket, we pay close to 50% on our last dollars of taxable income, this means a pre-tax return on our investments of $1,200 each, however, since you have invested outside of an RRSP, you will have to pay close to $600 in taxes whereas my entire return will be reinvested.” Steve pauses for a second and starts writing something. He looks up and continues, “Let’s assume that this initial investment continues to earn a return of 8% for 25 years. If your earnings were all in interest, which is taxed at your marginal rate of approximately 50%, your portfolio would only be worth $39,987.54, while mine inside an RRSP would be worth $102,727.13 and that’s if I didn’t reinvest my refund. By reinvesting the refund in the second year, the RRSP balloons up to $150,285.98.”

“But you will have to pay taxes on that amount one way or another.” Lisa interjects.

“True,” says Steve, “yet you know that the tax rate is never 100%! In fact, the more you’re taxed on, the more you keep. Besides, most people retire on incomes that are lower than pre-retirement income, which generally means a lower tax bracket after retirement.”

“Well you’ve done it,” says Jeff “I’m convinced. How did you learn all this stuff?”

“We have a great money manager that actually takes the time to explain our options to us.

Adena Franz is a Vice President and Portfolio Manager at MacDougall MacDougall & MacTier Inc. She can be reached at 514-394-3771. The information contained in this article is for general information purposes only. It does not account for specific investment objectives or the financial situation of any person reading it. Opinions expressed are those of the author and do not necessarily represent the opinions of MacDougall, MacDougall & MacTier Inc. Investors should seek professional advice regarding the appropriateness of investing in any securities discussed or recommended here and should recognize that statements regarding future prospects may not be realized.

MacDougall, MacDougall & MacTier Inc.
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