Critical look at RRSPs

Here are four factors that reduce the attractiveness of RRSPs

Are RRSPs always the best strategy?

This financial planning belief has been accepted for decades as a universal truth believed by most Canadians, including myself, until recently. Question everything! It is obvious that for income-based goals such as retirement and education, after-tax income is all that matters.

I am not against RRSPs. With the refund reinvested, RRSPs generally are better than unsheltered investments. But not always, as we will see.

Before anyone can change their beliefs, especially on a long-held view that forms the foundation of financial planning, it is critical to understand how a non-registered approach could be better than RRSPs.

It is important to not overlook the fact that, with any unregistered investment, you always get your own money -- your original principal -- back both tax- and clawback-free.

The following are factors that reduce the attractiveness of RRSPs:

1. Most investors fail to reinvest their RRSP refund. A refund that is spent increases your current standard of living, but generates no future retirement income. By not reinvesting the 30-to-50% refund, you decrease the after-tax amount invested by 30-to-50%. It is possible that a larger amount growing in a less tax-efficient, unregistered investment could produce a higher after-tax retirement income.

2. Tax deferral is less valuable as investment growth decreases. Besides the tax deduction, the other main benefit of RRSPs is tax deferral. Deferring tax is less valuable when the investment growth decreases. Growth decreases as the time invested decreases. This means that RRSPs become less valuable as you get closer to retirement. The need for tax deferral also decreases as returns decrease.

3. Clawbacks could increase in the future. If tax rates, including clawbacks, rise, this would clearly hurt the fully taxable RRSP strategy more than unregistered strategies. Capital gains have tax deferral similar to RRSPs and are later taxed less.

4. Your investments are restricted. If foreign content limits restrict access to historically higher returns of global equity funds, this hurts RRSPs in terms of potential returns and risk.

Conceptually, it should be clear that if one or more of these factors is tipped enough in the wrong direction, keeping your equity investments outside of RRSPs could produce more after-tax retirement income.

Talbot Stevens is a financial educator, speaker and author of Financial Freedom without Sacrifice. Phone (519) 663-2252.

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