Way back in Lesson 2, I talked about how your TFSA is your best friend. It really is because the government of Canada has given you the opportunity to invest absolutely tax free on your gains. This becomes extremely beneficial over time when the effect of compounding becomes quite noticeable on what develops into a large sum of money later down the road.
Just like the TFSA account with its perks, you can also take advantage of investing additional money in your RRSP. I would recommend filling your TFSA first before putting your money in an RRSP or margin account, especially if the purpose is for long term investing. However, there are some benefits to putting money into an RRSP instead of a TFSA or other investment vehicles.
A Registered Retirement Savings Plan, or RRSP, is another investment vehicle offered by the Canadian government that gives people the opportunity to invest money in an account and be "rewarded" for doing so. By rewarding, I mean that by investing in an RRSP account, you will receive a tax credit of around 30% of what you contributed to your RRSP. This to me is the primary advantage of putting money in here. If Jim puts in $5,000 into his RRSP account to invest this year in 2018, when he does his 2018 taxes next year, he can claim this contribution and be expected to be credited around $1500. As discussed in Lesson 18, turning the same dollar over and over is how you can grow your wealth without any real added effort. This is a perfect example of that. Jim can now either invest that $1500 in his TFSA account if he has extra contribution room, invest it back into his RRSP and get another tax credit back the following year on the $1500, or invest it really anywhere he wants.
The main difference with the RRSP account compared to the TFSA account is that when money is pulled out of an RRSP account, that amount becomes part of your taxable income for that year. This is why it's important to plan ahead in retirement and slowly draw from your RRSP year over year rather than withdraw the total lump sum in one shot. If Sarah has $500,000 in her RRSP and has reached the age of 65 and is retired, it would be advantageous for her to slowly pull money out, maybe at $20,000 increments year over year. She will get taxed on this $20,000 in any given year as if it's personal income. Fortunately, the amount is low enough to keep Sarah in a low tax bracket. However, if Sarah abruptly draws all $500,000 out in the first year of retirement, she will be taxed as if she has personal income of $500,000 in that given year. Her tax rate would be enormous and she will end up paying probably at least $200,000 in taxes. 40% of her retirement savings is evaporated because of this egregious error that could have been avoided, and surprisingly enough, this does happen to many seniors who do not have enough financial acumen to realize this costly mistake, or who have not consulted a financial wealth planner.
Another benefit of the RRSP account is the "first time home buyers" plan. This plan states that an individual can pull out up to $25,000 out of their RRSP for the purpose of purchasing their first home, without being taxed on this withdrawn amount as personal income. If two people are purchasing a home together who are both first time home buyers, they both can pull out $25,000 from their RRSPs for a combined total of $50,000 towards the home purchase. The individual is also not required to pay this money back into the RRSP immediately, but instead has a 15 year timeline to do so. What some individuals will do is contribute an amount that would have been the down payment for their first home into the RRSP account, and then immediately pull it out. Although this does mean that the individual must contribute the withdrawn amount back within 15 years to avoid penalties, it does mean that the individual will get a tax credit for the amount contributed. If Jerry has set aside $50,000 to buy his first home, he may decide to throw $25,000 into his RRSP today. Tomorrow, he will withdraw that $25,000 so he can buy his home under the first time home buyers plan. He figures that by the time 15 years rolls around, he will have naturally contributed at least $25,000 back into his RRSP. Not only will Jerry receive a tax credit the following year for his $25,000 RRSP contribution, but he has essentially created wealth for himself without any effort or major risk by creating a $25,000 tax free loan. The only risk in this scenario would be Jerry's inability to pay back $25,000 into his RRSP in 15 years, or that he is not able to make the minimum annual payments into his RRSP (RRSP repayment/15 years). However, if someone regularly contributes to their RRSP annually anyway at a sufficient rate (greater than the withdrawn amount divided by 15 years, which means that the maximum annual payment would be $25,000/15 = $1667), meeting this payback threshold will just naturally happen without any added financial distress to the individual. Not meeting the minimum annual payments and inability to contribute back the withdrawn amount will result in the individual being taxed on the amount not repaid, which completely defeats the purpose of taking out this tax free loan under the home buyers plan.
Investing money in an RRSP account can be extremely beneficial if done properly and responsibly. Whether using the first time home buyers plan, or making annual contributions, receiving tax credits the following year can help grow one's wealth and turn the same dollar over and over without any effort or financial distress. Just remember that under normal circumstances, whatever is pulled out of an RRSP account is taxed as personal income, regardless of how old you are. If you are considering pulling out money before retirement (and not for the first home buyers plan), only do so in the event of an emergency, and only pull out what you have to. This account can be your second best friend if utilized properly to ensure you have a sufficient level of wealth for retirement. After all, the account name does have the word "Retirement" in it because that's what it's meant for.