London, ON: "As Canadians head into the New Year and RRSP season, most investors will be hurt by an overlooked behavioural trap that significantly reduces their retirement funds," says Talbot Stevens, author of the new book, The Smart Debt Coach. But it doesn't have to be that way.

While there is a ton of information available on the subject of RRSPs, there is one fundamental concept that most investors don't understand, which would increase their retirement savings by 25 to 100%. "The hidden behavioural risk of RRSPs is what happens to the refund," says Stevens. "If you spend your RRSP refund, as most do, you unknowingly end up investing less than you started with, and less than most think." Stevens explains that there are five RRSP Refund Strategies, each reflecting a different type of investor behaviour, and commitment to retirement.

Don't Put Dry Pasta in Your RRSP

The key concept that RRSP investors need to understand is difference between after-tax dollars -- what we get to spend or save, and before-tax dollars -- like those in an RRSP. Stevens uses the off-the-wall metaphor of pasta to help investors get the message, and advises that you "never put dry pasta in your RRSP." Before-tax dollars are like larger, wet, cooked pasta. But after income taxes suck all of the water out, you're left with smaller, dry pasta.

He offers an example to illustrate how you can increase your RRSP contributions by 25 to 100%, depending on your tax bracket. To keep the math simple, let's assume that Kim is in a 50% tax bracket. If Kim has $1,000 after taxes to invest, puts it in her RRSP and spends the $500 refund, she ends up with $1,000 more in her RRSP. But without realizing it, she has converted after-tax dollars into before-tax dollars, and ends up contributing less to her savings than she started with. For her, $1,000 before tax in an RRSP is only worth $500 after paying 50% tax. She started with $1,000 after tax to invest, and by spending the refund, really only added $500 after tax to her retirement fund. She put the smaller, dry pasta in her RRSP.

Stevens' experience is that for the vast majority of Canadians, RRSPs are really "Registered Retirement Spend-the-refunds Plans." This is the first, and unfortunately most common, RRSP Refund Strategy.

If Kim is focused on retirement, she could use the second refund strategy and reinvest the tax refund. Here, reinvesting her $500 refund would turn Kim's $1,000 into a total contribution of $1,500 -- an improvement of 50%. While some RRSPs discussions are starting to talk about what happens to refunds and the benefits of reinvesting them, Stevens cautions that this is only partially cooked pasta. "Investors can, and need to do better, or they could be better off not using RRSPs," he warns. For Kim, $1,500 in an RRSP equates to $750 after taxes, still less than the $1,000 she started with.

To get all of her initial after-tax fuel in her retirement vehicle, Kim needs to use the third refund strategy and "gross up" her after-tax dollars to the full, equivalent, before-tax amount. In a 50% tax bracket, $2,000 before tax in an RRSP becomes $1,000 after taxes. So for investors like Kim, $1,000 after tax to invest really should become a $2,000 RRSP contribution -- 100% more than what most Canadians invest by spending their refunds.

How can she do that? One way is to temporarily borrow an extra $1,000 late in RRSP season to make a $2,000 contribution. This produces a $1,000 refund, which is enough to completely and almost immediately repay the $1,000 loan.

To help RRSP investors understand how to invest the equivalent, before-tax amount, Stevens has free resources on his website that includes the related chapter from his book, The Smart Debt Coach, and a calculator to find out how you could increase your RRSP contribution, for your tax bracket. To learn more, visit www.SmartDebtCoach.com/pasta.

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Talbot Stevens is a speaker and author of The Smart Debt Coach. His first books Financial Freedom Without Sacrifice and Dispelling the Myths of Borrowing to Invest have sold almost a quarter of a million copies. For more information, contact Talbot Stevens, by calling (519) 663-2252, or emailing talbot@TalbotStevens.com.

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