EP05 - WealthSmarts - Why People Hate RRSP's | WealthSmart

EP05 – WealthSmarts – Why People Hate RRSP’s

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For that matter, they might even have somebody that AIDS and abets their behavior in reacting to the market. And the person helping them will say yes sir, yes ma’am will do that right away for you. This is well smart where you will gain the financial capabilities and confidence to achieve the goals that matter to you now. Here are your host. Richard and matt 1957 was a very great year. Oh tell me why. Well my mom and dad got married. Okay. And I think that’s pretty important without that we probably wouldn’t be here. Absolute.

I’m happy for that. Another great thing happened in 1957 though. Okay. The government of Canada created the registered retirement savings plan or the R. R. S. P. For short. And it’s kind of funny but they created it in order to give Canadians tax incentives that would encourage them to save for their retirement and ultimately not be a burden on the state, you could say. So people could take care of saving on their own to secure great futures for themselves and for their kids. But a lot of people don’t trust that you trust everything Canada Revenue Agency does Sierra does.

I think that’s a trick question. Uh That’s an interesting way to start the podcast. You know, I gotta give CRE credit, they are necessary. Like look at everything that we get in this country, all the good things that we have. It’s because we have a a pretty decent taxation system and we can’t get along without it. There’s things that we don’t like about it but we need it. But one thing that they’ve done is is even though we know that their job is to tax our income and tax it both now and in the future, attacks the growth of our investments etcetera.

The tax incentives that are available with the R. S. P. Sometimes seem too good to be true and that’s understandable because we get a lot of questions about R. S. P. S. And we get a lot of interesting comments that we wanted to go through in this podcast. What are the top ones? Well why should we invest in an RSP when you have to eventually pay back all the money you save? I understand the question and I feel for the people that are asking that question but I like to rephrase how the RSP actually works.

We often think about the RSP as okay, we put a bunch of money let’s say 10,000 bucks into an RSP and we do it in time for the deadline like March 1st, our february 29th in a leap year. And when we do that, the government then gives us money back after we file our taxes. That’s the way of thinking about it, is that we get money back from the government. I’d like to reframe that because what it actually is Is, let’s just say we want to put aside 10,000 into an RSP.

What we’re actually doing Is we’re setting aside 10,000 of our income and using that and growing that for our retirement so that when we take it out, we can derive an income from it. And the way the RSP works is it doesn’t tax that portion of your income that you set aside and what that does, that shows up as a tax refund, but it’s actually they’re simply not taxing that portion of income that we set aside and we usually set it aside when we’re in a higher tax bracket in the working years, then we will be in our retirement years.

So yeah, we’re going to eventually pay tax on it. But what happens in the meantime is when it’s growing, we’ve got that not only do we have that 10,000 growing? If we didn’t use the RSP we would have had to pay tax on that 10,000 of income In a 40 tax bracket. Let’s say that we only get 6000 of net income, which we can then put into an investment and then there’s only 6000 compounding, you know, in creating a tax deferred rate of return. So what we have instead is we have a full 10,000 growing and then if it’s making eight It’s making eight on 8 on eight on 8%.

And if it wasn’t and that was being taxed, we’d actually be only making like 4. 8 on 4. 8 on 4. 8, that’s where we’re going. And the compound effect of that is monumental. Of eight versus 4. 8 compounded. So it’s still the best tax tool that we have going available to Canadians today, interesting. So another common question we get is I’m better off investing my money in my T. F. S. A. I think about that. The T. F. S. A. Is quite flexible for a variety of different reasons. It’s an awesome tool. What was the first investment that I encouraged you guys to invest in TFS is absolutely why did we do that?

The flexibility I think. And also because of our income level you had a lower income tax bracket. Is your income in the future going to be higher than it was when you first came out of university? Of course. I think so. Yeah, hopefully we’ll yeah we’ll see what we knew about that. But I think in those years that you were building your capacity to earn an income while you were still studying all your courses and everything like that, your income was lower. You wouldn’t have derived the same benefits from the RSP as later on.

So you’re waiting to put into the RSP until your higher income here and lo and behold after you guys got married and everything like that and building the business together, your income rose and you’re starting to put into RSP. But the T. F. S. A. Was the first vehicle. T. F. S. A. Is a great vehicle especially for young people to begin with because chances are they’re going to take that money out. A lot of it use it for a down payment on a house, get a mortgage into place and then they their incomes will go up.

RSP will be a better idea. So it all depends on what stage in life you’re at. So this is great but it all depends on what your tax bracket is now and what your tax bracket is going to be in retirement. And whether you may need that lump sum of money in the near future. And if you do that T. F. S. A. Definitely is a better idea. Yeah. And I think the big thing with the T. F. S. A. Is not only the flexibility of it, but we also have to consider that the T. F. S. A. Contributions are made with after tax dollars while RSP contributions are made with pretax dollars.

Well let’s take a look at that example of 10,000. We talked about your in a 40% rate. After that money gets taxed at 10,000 of income gets taxed. You’re left with 6000. You can put that into a FSA but you lost 4000 in taxes. But if you’re in a situation where in a high tax bracket and you’re maximizing your RSP T. F. S. A. Is a really strong second. And you know what sometimes it’s a combination depending on circumstances. It’s not either or I’d say it’s a combination of both. In both.

In most cases the most ideal situation would be to max up both of them. That would be great. Yeah. And you know what I talked to a young man the other day is 20 years old. He’s just starting off in his career. You know his father referred him and the best thing that I suggested for him long term as his baseline is going to be his T. F. S. A. Because I showed him that if he took that T. F. S. A. And only put in 6000 year into his FSA by the time he’s 60 he’s going to be a millionaire now.

We want him to do better than that because the millions are not going to buy too much in 40 years. But he’s going to have a million dollars in this T. F. S. A. He’s also putting into an RSP. So that’s going to be for his retirement is going to be a very wealthy man when he retires power of time. It is true. Right? So what we’re really saying here is if your income tax rate and retirement is lower than during your working years, RSP should take priority.

Yeah, for sure. Yeah. We can run the numbers. A lot of people might make a very quick decision on. No, I’m just gonna invest in TFS a without considering the data and I’d really encourage you take a look at the data. We’ve done these numbers backwards and forwards in the show notes on this podcast. We’re going to show you some calculators that you can use to actually run those numbers. The next big objection. It’s better to pay down my debts. I agree. Depending on what kind of debts we’re talking about. Yes. Okay.

What kind of debts to you or bad debts? Um let’s say the ones that they’re charging you 19%. That’s wonderful. You know, I was talking to somebody the other day about that and uh you know, the whole idea for him and his wife was, well let’s pay down the mortgage. And I said, you know that might not be the better idea Because I know that there’s some credit card debt there and said, you know what, that’s costing a 19%. You need to take care of that because that’s bleeding you and then you’ll have the capacity to address the whole mortgage pay down thing.

But bad debts are consumer and credit card debts that are at a high rate. And very often the rate of return, the interest rate that we’re paying on those debts is way higher than the rate of return that we can possibly expect long term on a portfolio. Now on the other hand, If we have a mortgage and especially with today’s rates were around the two range or less even I’d say that in the long term your rate of return on a balanced portfolio is going to be higher.

Well I shouldn’t make forward looking statements should I know historically over the past 100 years your rate of return on a balanced portfolio has been much higher than the average interest rate that you’re paying for a mortgage. So I would say choose a good amortization period for your mortgage, make sure your credit card and consumer debt is paid off and then maximize RS pays as much as possible into a good balanced portfolio, much like Canada pension plan or the BC pension plan or any other pension plan invests in.

Because I think in the long run will be much happier. And I think the key here too is when we focus too much on paying down like the low interest that what we have right now, it might prevent you from investing in your long term financial future. Like it might seem like the prudent thing to do, but it’s also you do need to consider the trade offs right? For sure. What’s another one putting too much money into an R. S. B. Will result in old age security clawbacks in my retirement, you know, always claw back.

Sounds like a horror movie, doesn’t it? Like I think of those horror stories that we tell each other, you know, while going through Stanley park on a that’s a bad idea, rainy night and stuff. But always clawbacks are bad and there are thing that we fear, but sometimes it’s a fear that’s not going to manifest itself in most cases now. If we were receiving os during our earning years right now, old age security during our earning years, we could expect to see much of that clawed back.

But let me put it in perspective for you. Okay, A lot of people don’t realize how much income you actually have to earn in order for that to start being clawed back. So if you qualify for full old age security payments at age 65 that’s about 610 bucks a month, assuming you’ve been in the country for at least 40 years And you also make more than 79,845. Okay, that’s in this year. If you’re making more than 79,845 and net world income in 2021, you will pay 15 on the excess of that amount until your income reaches 129,075.

And at that 0. 100 of your Israeli payments will have been clawed back. How many people that we know of and we’ve got a lot of clients who are in their retired years and they’re doing really, really well. But how many people realistically have more than 75,000 of retirement income each? It doesn’t happen very often, but sometimes it can happen. For instance, you sell a property at a capital gain in your retirement in that year. You could have some of your old age security clawed back. There are things that we can do to prepare for that, and that’s where a comprehensive financial plan comes in.

That’s where people need to work with a good financial advisor in order to make sure that they minimize those claw backs. But I would say that fear of os claw back if we take that word, fear has an acronym, which is false evidence appearing real. I think that applies most of the time. In this case, it’s it’s really not something that most people need to worry too much about. And I think even just having a financial plan to answer those questions is very important because otherwise we will jump to those assumptions, right?

And here’s a bonus. One that we hear a lot. RSP s just never worked for me. What do you mean by that? Well, like some people just they have or I’ve had are SPS and it never worked for them. And to those cases, I think there’s an important consideration that the RSP is just a vehicle. Yes. Yeah. We think it’s an investment, but it’s really a bucket. What might not have been working for you if we use this example is the engine and the gas that you put into it. Yeah.

So any comments on that? Well, if you take a look at the R. S. P. As a bucket and you think about what you’re putting into that, it can be rocket fuel and one match and that whole thing explodes. So you can try putting in investing in penny stocks and you’re expecting that to just explode in value. More than likely if you’re speculating like that, it’s not just going to explode in valley, it’s going to just explode and it’ll be gone okay if you’re putting in a nice balanced portfolio of global securities in the long run, I think you’re going to be okay.

A historically a portfolio that like that has given you an 8 to 10% rate of return, don’t know what it’s going to do in the future, but a portfolio like that is going to do better than, for instance, leaving it in cash. A lot of people will go to the bank or any other financial institutions. Okay. It’s March 1st. I need to put some money into an RSP and they transfer some money in and then they forget about it because they’re not dealing with a qualified person at the counter.

They’re dealing with somebody who’s paid in order to conduct a transaction for them and it ends up sitting in A daily interest savings account at best. And what’s that going for these days right now? Nothing. You know, it’s getting like . 2 or maybe they’ll put it into a term deposit and lock it up for . 75 and they’ll go through that journey of not having somebody qualified to help them construct a long term portfolio that’s going to help them reach the goals that matter and they’re going to have a disappointing experience.

So yeah, the the the end result in conclusion after that horrible experience over say a decade or so of putting money in and not seeing anything in return or for that matter, they might even have somebody that actually aids and abets their behavior in reacting to the market. So they’ll look up at the board that shows the rates of return of different funds and say oh okay that technology funded like 30% last year. Get me some of that, will you? And the person helping them will say yes sir, yes ma’am will do that right away for you.

They will aid and about their bad behavior because they’re gauging the future on things that have happened in the past. The same thing happens with bonds in a bad market. Let’s just say bonds might have done quite well as interest rates have dropped and they say put some money in that bond fund because it did six and my equities lost money. They will aid in a bet that behavior. So after the end of a number of years, 10 years, 20 years whatever they will have had a bad experience with their RSP.

But it’s not the R. S. P. S. Fault. Yes. Okay. I think I’m done that. I think that tangent was very very richard. Like this is a big picture. Yeah, the RSP as we said is just a bucket. It’s a tool, it’s a tool, very valuable tax planning tool and it has to fit within the structure of your financial plan. So many variables and exceptions that go beyond the scope of this conversation. So we’ve built a very content rich website. Okay, We’ve been busy at that over the past year or so.

And one thing that we have that we love and we refer to a lot is our calculator page. So if you go to our website, wealth smart dot C A. You’ll see at the bottom in the menu there’s a calculator menu item, you can choose that or wealth smart dot C. A slash calculators. If you go there, we’ll include something in the show notes. There’s a bunch of comparison tools there that allow us to evaluate whether or not this RSP can be a good idea and we know it is, we know that the data is true and it will also allow us to evaluate different ways of maximizing the impact of the behaviors and inputs that we put into that our recipe.

This is very true. And, and I think the more important thing is by using your own numbers and playing around with your own situation. It really puts it into the context of your life. Absolutely. And you know what, with the RSP, it’s something we shouldn’t always wait until february for like this is a year round conversation. Like you need to pay yourself first and and put together a systematic plans. Yeah. Something that you’re paying yourself once a month, for instance. Okay. Yeah, But more on that in another episode, I think.

So, we’re gonna we’re gonna talk about that in the future. Absolutely. Um Good. Thanks for raising these these issues and thanks for raising these concerns that people have about their RSP s. I think in our conversation here, we’ve answered a number of them. Thanks for listening to today’s episode of Well, Smart. Be sure to check out the show notes on our website for more information. If you’re not already subscribed, please subscribe or wherever you get your podcasts.