Friday, February 1, 2013

RRSP 101 or What Uncle Louie Taught Me 35 Years Ago

It's that time of year again folks. RSP season. (Note: when you purchase an RSP, it is called an RSP. When you then declare it and file it with your income tax return, it becomes an RRSP or a "R"egistered RSP). Many people debate on whether it is good or bad to invest in an RSP.  Shockingly, if that's a word, only 26% of eligible tax filers contributed to RRSP's in 2010 according to Statistics Canada (latest stat I could find).
This is silly folks, and here's why.
Uncle Louie told me the following in the mid-70's, and Uncle Louie is the family expert on finance. He was a working man all of his life, and yet he and Auntie Kaye lived a wonderful prosperous life without any money concerns until they passed away. And, left no debt, and, on the other hand, an estate upon their passing.
Now, back to the story. Uncle Louie said the following. If you do not have any money to put into an RSP, you should do it anyway, and here's how. First, go to your bank and borrow the money. Then, put it into an RSP. Then file your taxes, get your refund, use it to pay off a reasonable portion of the borrowing and make sure that you pay the rest of it off before next RSP tax time rolls around so that you can do it all again.
Watch the math:
Let's say you have $60,000 in taxable income (before any RRSP investments). Here is what Ernst & Young say you will pay in taxes on their website at :

So, let's use Ontario as the example. If you live in Ontario, then on your $60,000 taxable income, you are donating $12,002 to Mr. Harper and Ms. Wynn to help keep Ottawa and Ontario afloat.
Now, your RSP contribution amount, is 18% of the previous year earned income. So, let's say that's probably around $12,000.
O.K., how will $12,000 affect your tax payable. So, below:

Now, your tax payable is $8,264. That means that while you think you contributed $12,000 to an RSP, you actually contributed $8,262, and the Government(s) contributed $3,738. Yet, you have a RSP savings account that says $12,000 in it. In other words, on the day you contributed, you got interest of 45%. However, you do have to pay back the loan. 
So, let's do that math. If we use the major banks as an example, the interest on RSP loan is approximately 4%. If we use the Golden Rule of RSP Payback, and pay the loan back in 12 months, just in time to borrow again, the monthly payments are $1,021.80. Or, $261.60 in interest. But, remember, the Goverment(s) just sent you a cheque for $3,738 which covers almost 4 months of payments. 
So, what's the bottom line. You put $8,262 in principal plus $261.60 in loan repayment amounts and wound up with a savings account worth $12,130.44 (The extra $130.44 is interest earned at a measly 2%). This is a no brainer.
Further, if you start in your 20's, you retire wealthy, at least wealthy enough not to have to worry about whether the Goverment(s) will have any money to help you in retirement, and, without having to burden the next generation with your retirement needs.
Drop what you're doing, run to the bank, buy an RSP and thank Uncle Louie for his sage advice!


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