Martin Gale form Efficient Market Canada just wrote an amazing piece, laying out the case for RRSPs over non-registered investment in a growth stock, a dividend stock, and a mortgage payment. This article is a MUST READ for anyone who has every wondered if investing outside an RRSP has some advantages over investing inside an RRSP. Or if you have ever wondered if you should pay down your mortgage rather than investing in an RRSP. Here’s the set-up:
Are people really better off saving money outside of an RRSP? Some say buying and holding growth stocks that pay no dividends is another way to defer taxes, and that investments in an RRSP lose access to the dividend tax credit. Others say that it’s better to repay your mortgage than invest in an RRSP There are a lot of people out there who say things like this and they are almost always wrong. The arguments for non-registered investments generally involve a lot of handwaving and grand claims so let’s break it down and look at the numbers. First we’ll look at buying stocks in and out of an RRSP, then we’ll compare an RRSP to a mortgage payment.
This article is going to be a straight-forward proof that investments in an RRSP beat investments outside of an RRSP in terms of expected returns.
A couple notes about his calculations… As he says, “Note that if anything these assumptions bias against the RRSP because for many people the tax on withdrawals from an RRSP will be lower in retirement than the tax saved at contribution time.” He goes on to give a good reason for why this is usually the case. Another reason these calculations are biased against the RRSP is because he neglects the fact that the investments outside the RRSP might be taxed every year if you are selling your investments every year and buying new ones, for example, whereas inside the RRSP your investments will experience tax-free growth. I just did a quick back of the envelope calculation and this does make a difference.
In the end the RRSP wins out in each case, even though some simplifications in the calculations bias the calculations against RRSPs. The key reason the RRSP comes out ahead, as he explains so well, is because of double taxation outside the RRSP. Taxation on your income (off your paycheque), then taxation on the gains made off those investmentes. In the RRSP you are only taxed once, when you withdraw the entire thing, your gross income plus gains from the RRSP as income.
Almost everyone who argues that the non-RRSP is better ignores the fact that the non-RRSP payment was made with after tax dollars, in other words, they ignore the double taxation.
Around this same time last year I looked at a Phillips, Hagar, & North report that compared investing in an RRSP with investing outside an RRSP. It was called “The Retirement Savings Debate: Inside or outside the RRSP structure” and their conclusion was that
saving for retirement using a registered plan (RRSP) is more beneficial than saving in a non-registered, taxable account. There are a few exceptions to this, but for the most part, this conclusion will hold true for the majority of middle- and upper-income earners.
If anyone finds that PH&N report, let me know. That blog post also had a quote from Derek Foster, which after looking at it again, now seems like total bunk.
I also wrote about paying down student loans vs. contributing to an RRSP although I neglected a few things (see comments).