Not fully understanding how compound interest works is one reason people may fail to appreciate the benefit of making RRSP contributions and saving for retirement.
“At a marginal tax rate of 40 per cent, someone holding an investment generating five per cent interest annually would earn five per cent if it were held inside an RRSP, but only three per cent if held outside,” explains Dr. Amin Mawani, FCPA, FCMA, associate professor at York University Schulich School of Business. This is because the interest on investments held outside RRSPs are taxable and must be paid each year.
“Over a 30-year horizon, a one-time $10,000 investment yielding 5 per cent would grow to $43,219 inside an RRSP, but only to $24,273 outside an RRSP,” Mawani continues. “If $10,000 were contributed each year for 30 years, then the amount accumulated inside an RRSP would be $664,390. Outside, it would be $475,750 – nearly $190,000 less.”
True, taxes must be paid on accumulated RRSP funds when they’re withdrawn; the greater the funds, the greater the tax bill. Mawani says, however, that this could be managed by setting aside the initial refund from the RRSP contribution and letting it grow for 30 years as well.
Chartered Professional Accounts of Ontario
