Right after making your RRSP contribution, did you have that fleeting thought: could RRSP actually be a scam?
After immigrating from Hong Kong to Canada, the first thing I did was study the country’s tax system. Canada’s financial system is actually designed with great precision, with various registered accounts, tax benefits, and social benefits all intertwined.
Today, let’s talk about RRSP (Registered Retirement Savings Plan). As for the usual advantages of RRSP — tax deductions, tax deferral, retirement savings, and so on — banks and financial advisors have already said plenty about those, so I will not repeat them here.
To be honest, I do have a bias against many tax systems. Whenever something that could have been simple is designed to be highly complex, I tend to wonder — is this some kind of scam? (Of course, that is just my personal bias lol.)
Let’s look at a simple example.
Suppose my marginal tax rate this year is 20%, and I contribute $1,000 to an RRSP.
That means the maximum tax I can save this year is:
$1,000 × 20% = $200
Sounds great, right? But think one step further. Suppose the investment inside my RRSP performs extremely well and grows by 200% by the time I retire.
In other words:
$1,000 → $3,000
So here is the question: if the same $3,000 is withdrawn from an RRSP versus a regular investment account, how much tax difference is there?
Scenario 1: RRSP
Assume my tax rate in retirement is 15%. When you withdraw from an RRSP, the entire amount is treated as income.
So: $3,000 × 15% = $450
Scenario 2: Regular Investment Account
With a regular investment account, the situation is completely different.
The principal is $1,000, and the gain is $2,000. In Canada, only 50% of capital gains are taxable (assuming the rules do not change lol).
So the taxable amount would be:
($3,000 − $1,000) ÷ 2 = $1,000
Then apply the tax rate:
$1,000 × 15% = $150
Final comparison:
RRSP: $450 tax
Regular investment account: $150 tax
But do not forget: when I contributed to the RRSP, I had already saved $200 in tax that year.
So the final comparison becomes:
RRSP effective tax burden: $450 − $200 = $250
Regular investment account: $150
The result is that the regular investment account actually ends up paying $100 less tax.
My thoughts:
To be honest, what I dislike most is this kind of tax design: extremely complicated, with a very long time horizon. You make a decision today, and you may not know the outcome until 30 years later.
Life in Canada is already not easy. Yet even in retirement, you still have to keep calculating RRSPs, RRIFs, OAS clawbacks, and various tax brackets. It feels as though you spend your whole life trying to outsmart the government.
How tragic…
Still, once you learn how to adapt to the rules of the game and legally make them work in your favor, there are definitely advantages to be had.
If you’re not sure whether RRSP actually fits your situation, feel free to email me — happy to walk through it with you.
Updated from time to time. More next time.