Happy Adds $298,445 To His Retirement Plan Without Saving a Single Penny More
Thursday, March 07, 2024
Happy Adds $298,445 To His Retirement Plan Without Saving a Single Penny More
Thursday, March 07, 2024
Welcome to my first edition of Happy and Virginia’s journey to wealth creation.
Just recently I was talking to a person (Happy) who informed me that over the recent years they’ve been working up the corporate ladder and are now earning a healthy salary.
However, his savings plan has not adjusted accordingly.
For good reason.
I personally think if you are earning less than $111,773/year in 2024 then the TFSA is the way to go.
But once you reach this milestone, it’s time to make the switch to the trusty RRSP.
Here’s why.
If you save $10,000/year into an RRSP and receive 40% back, you can take the government’s money and make more money for yourself.
In practice, it looks like this:
| Year 1 | Year 2 |
|---|---|
| Invest $10,000 into RRSPs in a 40% tax bracket. Receive a $4,000 tax return. Invest the $4,000 into RRSPs and claim them the following year. As a result, you’ve now saved $14,000 |
Invest $10,000 into RRSPs plus the $4,000 from last year in a 40% tax bracket. Receive a $5,600 tax return. Invest the $5,600 into RRSPs and claim them the following year. After two years you’ve turned $20,000 of contributions into $29,600. Versus a $20,000 contribution into your TFSA. |
Now, repeat this process for 35 years at 6% and you have a savings increase of $788,175.
| Lifetime RRSP Savings | Lifetime TFSA Savings | Difference | Value of RRSP at Savings End | Value of TFSA at Savings End | Difference |
|---|---|---|---|---|---|
| $600,000 | $360,000 | $240,000 | $2,087,978 | $1,299,803 | $788,175 |
But wait, you still have to pay taxes on RRSP withdrawals so to make all things equal, apples to apples, let’s carry this forward into retirement.
The true benefit of RRSP contributions is they will most likely be spent in a lower tax bracket.
If Happy redeems the money in a 30% tax bracket, he will be able to redeem $2,696,240 after taxes over the course of his retirement.
That’s $298,445 more than his planned TFSA contributions.
| Lifetime Net RRSP Redemptions | Lifetime Net TFSA Redemptions | Difference | Annual Average Redemption Difference |
|---|---|---|---|
| $2,696,240 | $2,397,795 | $298,445 | $11,938 |
Warning: If you spend your tax return instead of investing it, you’re going to get hit by a Volkswagen.
Yes, the only way this strategy works is if you reinvest your tax refund from your RRSP deductions.
If you spend it, the RRSP will not increase your retirement income.
If you spend it, your TFSA is the far better option.
Not by a little bit either. By $718,339!
| Lifetime Net RRSP Redemptions | Lifetime Net TFSA Redemptions | Difference | Annual Average Redemption Difference |
|---|---|---|---|
| $1,678,457 | $2,397,795 | ($719,339) | ($28,774) |
Conclusion
If you’re going to invest in RRSPs, make sure you’re also reinvesting your tax returns the following year. This way, you can realize the true compounding power of RRSPs. If you plan on spending your return every year, then you might want to consider a TFSA only strategy. In addition, revisit your tax strategy annually so you get to your “happy place” as soon as possible.
Hi, I Am Mitch Zaba
Over the past 10+ years, we've worked closely with clients showing them how to grow their wealth, pay less taxes and how to create predictable passive income in the stock market.
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