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1. RRSP Investment: $5,000 invested at beginning of year at age 35 and employer adjusts source deductions (ie the full 5000 is invested up front and there is no refund the following April).
2. Non-RRSP Investment is done with after-tax dollars: $5,000*(1-marginal tax rate)
3. Retire at age 65 and withdraw all funds over a 10 year period - withdrawls indexed to inflation so that the withdrawl the second year is 3% greater than in year one.
4. Rate of return on RRSP assets: 10%
5. Capital Gains inclusion rate: 50%
6. Inflation rate: 3%
7. All gains outside RRSP are assumed to come in the form of capital gains.

Marginal Tax Rate while working 25% 25% 35% 35% 35% 45% 45% 45%
Marginal Tax Rate at retirement 25% 35% 25% 35% 45% 25% 35% 45%

Rate of return on RRSP assets 10.0% 10.0% 10.0% 10.0% 10.0% 10.0% 10.0% 10.0%

Rate of return required to achieve the same retirement after-tax cash flow inside and outside RRSP
Absolute Buy & Hold 10.6% 10.4% 11.1% 10.9% 10.6% 11.6% 11.4% 11.1%
All gains taxed when earned 11.4% 11.0% 12.6% 12.1% 11.6% 14.0% 13.5% 12.9%

The "absolute buy and hold" means that once a stock is bought it is not sold until retirement so that all taxes are paid when the investment is sold. This is an unrealistic assumption but it is intended to test the best possible result of investing outside of registered plans. In this scenario, all gains accrue in the same tax deffered way as investments inside of the registered plan.
The "all gains taxed when earned" means that taxes are paid on all gains made during a given year. This is the other extreme and is intended to test the worst case scenario outside of registered plans. Note that under this scenario there is no tax liability at retirement once you begin to liquidate your investments (the only taxes paid are on the gains made on the balance of the portfolio). The available pool of savings is much less than the RRSP pool but the taxes paid when the investments are sold are also much less.

RRSPs more beneficial the higher your working marginal tax rate and the lower your retirement marginal rate
Choose non-registered investments if you can beat RRSP returns by:
>1.5% if you are in the low tax bracket
>2.5% if you are in the mid tax bracket
>3.5% if you are in the high tax bracket

Given that historical US market returns have been about 2% higher than in Canada (S&P 500 vs TSE 300) it can be said that those in the lower tax brackets should seriously consider investing close to 100% of their portfolios in US stocks. Furthermore, given the results from a poll I posted a few days ago, it seems many believe they can achieve significantly higher returns from investing in (high growth) US stocks. Risk tollerant individuals could benefit from investing all their money outside of registered plans - even if in the highest tax brackets. YES you pay more taxes every year when you invest outside of registered plans BUT your tax burden in retirement is MUCH LOWER, so that in certain cases, your AFTER-TAX cash flow is higher having invested your savings outside of registered plans - short-term pain for long-term gain if you will.

There are other advantages to non-registered plans which have not been accounted for in the calculations but which have sigificant benefits. These include:
1. Ability to use your portfolio assets as collateral.
2. Interest on funds borrowed for non-registered investment are tax deductible.
3. RRSP funds have to be converted to RRIFs at age 69(ie you have to begin withdrawing the funds) and therefore potentially putting you in a higher tax bracket even if you do not need the income. Non-registered investments do not have to be liquidated. Therefore, your tax planning is more flexible at retirement.

Final conclusion: While RRSPs may be great investment vehicles for some, they are not for everyone. Please do not follow the the heard and the Wise blindly - do a full and complete assessment of your individual LONG-TERM circumstances before you "max your RRSP".


PS For what it's worth, as a result of listening to the Wise in the past, I have all my current non-real estate retirement savings tied up in a self-directed RRSP. I DO NOT intend to add funds to this portfolio in the future!
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