I had a meeting last night with a lovely people selling all kinds of insurance. I've been talking about my long term and short term needs, investment vs. insurance and all about. As usually, the truth is came when you didn't expect it.
I have been curious about obsession of many Canadians to invest all possible money for the retirements. I heard something about RRSP and new that all the people around me contributing to the fund. RRSP stands for Registered Retirement Saving Account and you can read all the official information here I have got an impression of the following:
1. "Tax free" is not really tax free. It means that you have a delay of paying your taxes on the invested sum. I.e. you will pay taxes when you withdraw money from this account. How much? As much as your regular rate. You have an option to take as much as 5 dollars or as much as half million.
2. Your responsibility after death. If you die with a chunk of money sitting in your RRSP your spouse can get it transferred to her account "tax free", which still means that she/he will pay taxes upon withdrawal. If you are lucky enough and dead at the same day with your spouse your siblings or other people who will receive your money based on your will will pay.... ALL THE TAXES at once.
3. Interest on your investment. You will have to pay taxes on all interests you will receive from your investments. Usually, contributions to RRSP will not bring you much. So, automatically you will directly loose money on inflation rate. In 2011 inflation rate was 2.94%.
Now the math.
Let's say you want to invest/accumulate $100 (hundreds, thousands, millions) to RRSP in 10 years, and the average inflation rate is 2,1%. Your dividends might be as much as 0.1%. Therefore we simplify your yearly loses by combining inflation rate with dividends: %2.1 - %0.1 = %2 - of your net yearly looses.
In ten years you will loose 20%, which will leave you in bank with buying power equivalent of $80. Still you need to pay taxes on $100, which will be another 20% or $20. After everything paid you'll receive $60 from a contribution of $100.
Second, non RRSP option.
You pay your taxes (same 20%) in front and invest your money in stable funds/bond/shares with dividends of 4% a year for 10 years. Your investment of $100 after paying 20% taxes will be $80.
Every year you will receive $3.6 (and I am not talking that you might invest your dividends to the same fund). You still have to pay taxes from that $3.6, which will be $0.72. So, the pure income will be $2.88 or $28.80 in 10 years.
$100+$28.80 = $128.80
With correction on inflation rate will give you buying power of: $128.8 - 21% = $102.04
$102.04 vs $60. What would you choose?
Solution? Always simple. Retire the old scheme and get new age economics working for the country. I will share my vision on pension reform soon.
I would like to add that RRSP are working good if you receive contributions from your work - sometimes as a bonus they match the amount of your contribution to the plan. Also you might use your RRSP funds as a downpayment for "qualified real estate" which might be a good option for a first "qualified" home buyers.
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