When Should You Contribute to your RRSP?

How I finally settled on contributing to my RRSP

In my last job my employer matched up to 3% of my salary to my RRSP so contributing was a no brainer. My current company doesn’t match contributions so the question is back on the table. How do you decide whether to contribute to your RRSP or not? I decided a few calculations would be the best way to convince me and will walk you through the same steps.

I have always been a little uncertain about contributing to my RRSP. Tax deferred made me question the RRSP. If I was just going to pay the tax upon taking the money out how much of a benefit is it? And reading articles seemed to raise more questions than answers for me. Here is how I finally decided.

The factors I decided on:
  • Current income
  • Current tax rate
  • Expected retirement income
  • Predicted future tax rate (consider income + risk of changing tax brackets)
  • Expected annual return – how optimistic are you?

Step One: Calculate your tax refund for contributing to your RRSP


While you can calculate this on your own Simple Tax as a really easy calculator.

A screenshot of the simple tax calculator
Calculate your refund

As an example the calculator showed that by contributing $10,000 to your RRSP means a refund of $3,141. This refund is the deferred taxes. You already paid taxes on the $10,000 so the government refunds those taxes when you contribute to your RRSP. This refund is the ‘extra’ money you have to invest.

Step Two: Calculate your investment growth until retirement


Think of the refund as ‘extra money’ if you had put your $10,000 savings in a regular account you wouldn’t have the $3,141 to invest. Investing your tax refund is essential as that is the key benefit of your RRSP – you have more to invest now.

A graph showing how much
Savings + compound interest = growth

I am 30 and picked the arbitrary age of 75 to need the money – so depending on your age compound interest is in your favour. To get a range of how much the money would grow I assumed annual returns from 2% (low conservative estimate) to 5% (optimistic but possible). The chart shows the refund will be worth $7,500 to $28,000.

Step three: Calculate the taxes


When you take money out of your RRPS you are taxed. Use your best estimate – your income may change and the government’s tax rates will change so it is a best estimate. I assumed a 35% tax rate to be safe.

Using the same numbers as the chart above I estimated how much tax would be due when the full amount was withdrawn.

A table showing investment growth over 35 years
Upon retirement you will be ahead

After paying taxes (basically the cost of the refund now is paying the taxes later) you would have $5,000 to $18,000 in retirement.

Final Decision – invest in your RRSP!


The calculations show that even with returns as low as 2% a year you are better off contributing to your RRSP and investing the return. Deferring taxes gives your money time to grow in your pocket rather than the governments.

Links


Federal and provincial tax rates

The refund calculator I used

A good RRSP calculator to understand how much you should be contributing

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