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A tale of three options for your RRSP dollars

When it comes to saving for retirement, you've got many investment options. Yet, beyond investment choices, Canadians have more fundamental options to consider. Specifically, how to save for retirement.

Let's suppose you have $7,500 after taxes available to invest each year. I want to compare three options for that money: 1) Contributing that amount to your registered retirement savings plan if you have the contribution room; 2) Investing that money in an open (non-registered) account; or 3) Using that money to cover the interest cost on an interest-only loan to invest outside an RRSP.

RRSP option

If you contribute the $7,500 to your RRSP each year for 20 years, and reinvest your tax savings from the RRSP deduction annually, you'd end up with $322,773 after taxes at the end of 20 years. How so? You'd have $343,215 sitting in the RRSP after 20 years, at 8 per cent annually. Add to that $157,879 from reinvesting the tax savings (assume a 46-per-cent marginal tax rate) each year outside of your RRSP. I assume those tax savings also grow at 8 per cent annually in the form of capital gains. Finally, subtract $178,321 of tax owing after 20 years assuming a liquidation and withdrawal of all the investments at that time.

Open account option

Suppose you use the $7,500 annually to invest for 20 years outside an RRSP instead. In this case, you'd end up with $298,776 at the end of 20 years, after taxes upon liquidation, if we assume that you earn capital gains only and those gains are not taxed until the 20th year. If you were to earn interest income instead, taxed annually, you'd end up with $230,899 at the end of 20 years. Assuming the same 8-per-cent return and 46-per-cent marginal tax rate as the RRSP option.

Loan option

If the $7,500 annually was used to cover the interest on an interest-only loan at 7 per cent, you could borrow $107,000 to invest. You'd end up with $439,063 after taxes at the end of 20 years. This assumes you invest the $107,000 plus the tax savings from the interest deduction annually (at the same 8-per-cent return and 46-per-cent marginal tax rate). The $107,000 would grow to be worth $498,722 after 20 years. Add $157,879 from the reinvestment of the tax savings from the interest deduction. Finally, subtract taxes of $110,538 and the loan repayment of $107,000 at the end of 20 years upon liquidating the investments.

The bottom line is it's clear that using the $7,500 to cover the interest cost on an interest-only loan will leave you better off than contributing that same amount to an RRSP each year for two reasons: 1) You have more money working for you sooner; and 2) The liquidation of the account is more tax-efficient than withdrawals from the RRSP.

The loan strategy is less conservative than an RRSP strategy since you'll owe debt to the bank. The open account option alone leaves you with the least, largely because there are no tax savings in the picture to reinvest.

Some food for thought this RRSP season.

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