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The Companion Advisor: Taxes & Estates
How does an RRSP save me tax?
Stepping over the marginal tax rate barrier

RRSPs offer two substantial tax breaks. To really appreciate this, you should first be aware that Canada has a "progressive" - or escalating - income tax system.
That means the government set up a series of income levels with each level taxed at a higher rate than the one below it. Varying provincial income tax rates greatly complicate this structure, but generally:

  • Your first $6,500 or so of income is tax-free
  • The next $23,500 or so is taxed at about 25-29% depending on where you live
  • The next $29,000 or so is taxed at about 38-45%
  • On income above that level - $59,180 and over -you face tax of as much as 54%

How does your income fall into that lineup? The tax rate for your highest level of income is called your "marginal tax rate." For example, if you have $65,000 of taxable income, your marginal tax rate - the rate for the $5,820 that's over the $59,180 threshold - will be about 50-54% depending on the province you live in.

TAX BREAK #1
RRSP CONTRIBUTIONS ARE TAX-DEDUCTIBLE

This means you don't have to pay any tax now on the portion of your income that you put into your RRSP Suppose your contribution limit is $5,000 and you put in the full amount. Revenue Canada will let you subtract that much from your top level of income.

Immediate Tax Benefits

AT A MARGINAL TAX RATE OF
28%
43%
50%
Contribution
$5,000
$5,000
$5,000
Tax savings After-tax cost
of a $5,000 RRSP contribution
$1,400
$2,150
$2,500
Total
$3,600
$2,850
$2,500

MARGINAL TAX RATE


In effect, the government is giving you an interest-free loan. The tax you would have otherwise owed now goes to work in your personal investment account. Or look at it this way: If your marginal tax rate is 50%, you have a choice between investing $5,000 in your RRSP or paying $2,500 in tax and then investing $2,500 elsewhere.

TAX BREAK #2
TAX-SHELTERED GROWTH MEANS MUCH MORE GROWTH

Normally, you must pay tax on investment earnings each year. With an RRSP, you don't. As with the up-front tax deduction on your contribution, that means money that would normally go to Revenue Canada can now stay in your RRSP and earn still more money.

How much more?

MONEY GROWS FASTER INSIDE AN RRSP

$5,000 ANNUAL
CONTRIBUTION
RRSP
Unsheltered*
RRSP Advantage
Initial contribution
$ 5,000
$ 2,500
$ 2,500
Year 5
33,580
14,000
19,000
Year 10
87,660
33,020
54,000
Year 15
174,750
56,640
118,110
Year 20
315,010
86,800
228,210
Year 25
540,910
125,250
415,630
* at a 50% marginal tax rate. This table is used only for the purpose
of illustrating the effects of the compound growth rate and is not
intended to reflect future values or returns on any investment.


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Questions about the above send e-mail to:
moneyman@fiscalagents.com BACK

© , Fiscal Agents Money Management Newsletter
25 Lakeshore Road
Oakville, Ontario
L6K 1C6
(905) 844-7700





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The Money Management Newsletter:
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Taxes and Estate Planning