Your clients have until March 2 to make a contribution to their registered retirement savings plan (RRSP), if they want it to count toward their 2014 tax return.
It’s an important deadline, especially when fewer than 4 in 10 Canadians are confident that they’re saving enough for retirement. As well, recent surveys indicate only 8% of respondents are very satisfied with their retirement savings, and 30% are somewhat satisfied.1 And many are worried about outliving their retirement savings.2 That’s an understandable sentiment, since Canadians are living much longer than previous generations.3
When confronted with the prospect of living 10 years longer than they thought they would, Canadians from a wide range of ages revealed a significant pattern of uneasiness about their finances being adequate to cover their needs for those additional years4:
- Overall: 50% aren’t at all confident or don’t know
- Ages 18-24: 30%
- Ages 25-34: 51%
- Ages 35-44: 55%
- Ages 45-54: 61%
- Ages 55-64: 51%
The findings reveal it’s not only Canadians approaching retirement or in retirement who are concerned about living longer. Younger Canadians are also worried about having enough income to last as long as they live.
Many of your clients may also need help understanding the products that can help them save for retirement.
Gen Y – Only 14% strongly agree that they find investment products easy to understand.
Gen X – Only 16% strongly agree that they find investment products easy to understand.
Boomers – Only 18% strongly agree that they find investment products easy to understand.
Source: PMG Financial Planning Study, 2013.
The results show increased investment savvy as Canadians get older, but most still struggle to understand these products.
Demonstrate the value of your advice by explaining to your clients that one of the best ways to reduce their taxable income and save for the future is to contribute to an RRSP. Investments in an RRSP have two big advantages over investments held outside an RRSP:
1. Contributions are tax-deferred.
If your clients contribute to an RRSP, they can defer paying tax on that money. For instance, say they make $65,000 per year. By contributing $5,000 to an RRSP, they can deduct $5,000 from their taxable income for the year, saving the tax they would normally have had to pay on that $5,000. (Most people consider it “saving” tax, but the money is actually taxed when they eventually withdraw it.)
2. Money is sheltered from tax while it grows.
Investments inside an RRSP grow without being taxed, until they’re withdrawn, whether the growth is from:
- dividends, or
- capital gains.
Savings can grow quickly. Show your clients this chart, revealing the amount of money they could have for retirement by contributing to their RRSP for 30 years:
If your clients need more evidence as to why RRSPs are such a powerful tool for saving, compare these two scenarios:
Investing outside an RRSP
Suppose they wanted to invest $5,000 of their salary. Outside an RRSP, they’d first have to pay income tax of up to 50% (depending on their income and province of residence). That leaves them with as little as $2,500 to invest.
Then they invest the money in an equity mutual fund. Suppose their money is 100% in stocks, and they earn a 10% pre-tax profit, all of which is in capital gains. Half of capital gains are taxable, and if the investor is in the highest tax bracket, the resulting tax is 25%.
Assume they sold their investment a year after they bought it; they would lose a quarter of their profits. This means that they really made an after-tax return of 7.5%. If they continue to buy and sell investments each year for 20 years, their original $2,500 investment would be worth almost $11,000.
Investing inside an RRSP
If they invested $5,000 of their salary in an RRSP (assuming they have contribution room), they’d be ahead from the start. They could put the full $5,000 to work, as it wouldn’t be taxed.
Once inside their RRSP, any profits they make are sheltered from tax. If they earn an average of 10% a year in the stock market, they’d be able to enjoy a 10% average annual compound return. After 20 years, they’d have over $33,000. That’s three times the savings they’d have investing outside an RRSP.
When they eventually take the money out of their plan, it’s taxed. For many people, their marginal tax rate is lower when they retire. But even assuming it’s all taxed at a 50% marginal tax rate, it would still be worth almost $16,500. That’s still over 1½ times the savings they’d have from investing outside an RRSP.
Suggestions for the tax refund
When tax returns are larger, your clients have more options for their money. They can:
- Reduce debts – Pay them down starting with the highest interest first.
- Save the money – Roll the refund back into their RRSP or sock it away for a rainy day.
- Buy insurance – Increase their level of protection and security by putting it aside and using it to pay for the protection they and their families need.
Below are tools you can use with your clients to help them understand and set amounts for RRSP contributions:
- Registered retirement savings plans (RRSPs), simply put (Video)
- RRSP contributions and withdrawals calculator
- Pay off my mortgage or contribute to my RRSP tool
1 2014 Sun Life Canadian Unretirement Index.
2 Findings from the 2014 Sun Life Canadian Health Index found 45% of respondents are worried about outliving their retirement savings.
3 In Canada, a 65-year-old woman’s average life expectancy is almost age 87; a 65-year-old man’s average life expectancy is almost age 84. Thirty-five years ago, those averages were age 84 for women and age 80 for men. Life Tables, Statistics Canada, 2014.
4 2014 Sun Life Canadian Health Index.