A lot of my friends are starting to graduate from university, and they're entering the workforce. Naturally, their income levels are increasing, so a lot of my friends are asking me about RRSPs since they have a little money they can put away for retirement. So, I'm starting a series entitled the Newbies Guide To RRSPs. If you have absolutely no idea what an RRSP is, then you've come to the right place.
Why am I writing about RRSPs now? Well, you have until March 1, 2006 to contribute money into RRSPs for your 2005 taxes (I'll explain later).
My disclaimer as always is, please consult a professional financial advisor about money matters. I take no responsibility for any money you make or lose based on the advice I am providing. The only other disclaimer is to students currently in school and rely on student loans. RRSPs could count as assets, so it could affect how much money you can borrow for student loans. I don't know what the effects would be, but make sure you check first before going for an RRSP account. You have been warned.
So what makes me think that I can write about investing in RRSPs? Well, I did a business option in university, so that helps. I also have a respectable portfolio in my RRSP account. It's not bad considering that I've been a full-time student all this time. I've had this account for more than six years now (I started young).
What's an RRSP?
RRSP stands for "Registered Retirement Savings Plan." Essentially it's an account registered with the government which you put money into it, and invest the money for retirement. Why would you save for your retirement? Well, one of the side-effects of retiring is that you don't collect paycheques anymore. You might get a pension from the government, but no one really knows if the Canadian Pension Plan will even exist by the time we grow old. So, a retirement savings plan is a way to get some income when you're old.
The earlier you start investing in an RRSP, the better. I'll motivate this idea with an example.
Crunching The Numbers
Say you're currently 20 years old, and you expect to retire at 65. Let's assume that today, you put $100 into an RRSP account, and that money grew at a conservative 4% a year. 45 years later, you check on your RRSP account, and guess how much money you have in there? You would have $584.12.
The formula to use is:
(amount of money) x (1 + (growth rate / 100))^(number of years)
or
100 x (1 + (4 / 100)) ^ 45 // The ^ symbol is "to the power of"
That $100 would be $2100.25 if it grew at a modest 7% a year.
That $100 would be $7289.05 if it grew at an aggressive 10% a year.
That's a lot of money eh? But this example is pretty unrealistic because I'm assuming that you contribute $100 in your entire lifetime. In reality, people put money into their RRSP accounts every year. So, the growth of that money will be MUCH MORE dramatic.
Using this
financial calculator, you can get a more realistic picture of how much your investment could grow. I calculated the following: assume that you contribute $100/year into your RRSP for 45 years. So that's $4500 spread over 45 years.
The results:
4% growth/year yields: $12,349.96
7% growth/year yields: $30,603.74
10% growth/year yields: $83,422.43
That's some mad money right there.
How Can RRSPs Help Me In The Near Future?
There are several ways that contributing to RRSPs can benefit you for the near term. The first major and immediate benefit is tax relief. When you contribute money into an RRSP, that money is not taxed until you withdraw that money. In theory, the only time you will withdraw that money is when you retire, so RRSPs are known as tax-deferred investments.
Here's an example (taken from Royalbank).
Let's say that John Doe makes $30,000 a year, and Jane Doe makes $30,000 a year. Both John and Jane are taxed at 26% in Canada (provincial and federal taxes). Jane is smart, and she puts $3,000 into her RRSP account.
| | John Doe | Jane Doe |
| Gross Income | $30,000 | $30,000 |
| Net Income | $30,000 | $30,000 - $3,000 = $27,000 |
| Taxes (Net Income x 26%) | $7,800 | $7,020 |
As we can see, Jane Doe put $3,000 into her RRSP for the future, and she was able to save $780 in taxes this year.
There are other benefits of lowering your net income. For example, in BC, everyone pays the government for health care insurance which is known as the Medical Service Plan (MSP). Well, anyone that makes less than $28,000 a year in net income can get a discount on that insurance. From our example above, Jane Doe has just qualified for a MSP subsidy from the government while John Doe will be paying full price for health care coverage. You have to
apply to the government to get this subsidy.
The MSP subsidy is proportional to your net income. If your net income is less than
$28,000 - 20% off
$26,000 - 40% off
$24,000 - 60% off
$22,000 - 80% off
$20,000 - 100% off
