July 1998

Right Refund Strategy Increases
RRSP 30 to 50% or More, Part 1

© Talbot Stevens

This is the first of two Strategy Sheets that introduce a simple way to increase your RRSP income by 30 to 50% or more.

During my latest research project, I discovered a parameter that is critical to your RRSPs' ability to produce retirement income — yet, to the best of my knowledge, has never been discussed by the media.

By now, almost everyone is aware of the tax deduction and tax deferral benefits of RRSPs. However, how you invest in RRSPs, especially what you do with your tax refund, is an overlooked parameter that has a huge impact on the size of your retirement fund.

Since after-tax retirement income is the most significant long-term financial goal for most people, understanding and choosing the best Refund Strategy is critical to achieving that goal.

If you want to get the best return from your investment dollar, it is essential to evaluate investment strategies in terms of their ability to produce after-tax income over the desired time period.

To illustrate, let's say that Sue has $1,000 to invest and is in the 50% tax bracket.

If Sue invests the $1,000 outside of RRSPs, she makes an after-tax commitment of $1,000 to her retirement goal. This is because we only own after-tax dollars, where income taxes have already been paid.

I have identified at least five distinct RRSP Refund Strategies, each producing different levels of retirement income.

1: Spend refund. Unfortunately, the most common RRSP Refund Strategy is to spend it. If our primary goal is to produce never-ending retirement income, we must recognize that if the refund is spent, it produces absolutely no retirement benefit.

The $500 deduction reduces Sue's after-tax cost from $1,000 to $500. Therefore, if she spends the refund, Sue's after-tax commitment to her retirement goal is only $500.

To use a race analogy, the RRSP strategy where the refund is spent starts off way behind the non-registered strategy, but “runs” or advances faster with tax-free compounding. However, if the finish line is close enough, i.e. we are near enough to retirement, the non-registered investment can win at producing the most after-tax income over the desired retirement period.

2: Reinvest refund. A disciplined investor, Sue knows that to get the most retirement benefit from her RRSP, she must reinvest all of the refund back into the RRSP. Simply reinvesting the 30 to 50% tax refund increases your RRSP funds by the same 30 to 50%.

By reinvesting the $500 refund, Sue's RRSP starts at $1,500. The after-tax value, if immediately cashed in, would be 50% of $1,500 or $750. The after-tax commitment to her retirement goal is therefore $750.

Next month's Strategy Sheet outlines how Sue can do even better using one of three other RRSP Refund Strategies.

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