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The biggest RRSP myth? 1 + 1 = 3

Many people think a contribution, plus the refund, adds up to more than the contribution.

Registered Retirement Savings Plans are a great idea. They were Ottawa’s first big incentive to encourage retirement savings and they are the single most valuable tool to help you plan for retirement.

Tax Free Savings Accounts (TFSA) are a close second.

RRSPs were smartly conceived. They offer a psychological nudge to save by giving you a tax refund. So, it seems like something for nothing. You have the money saved, plus the money back: 1 + 1 = 3

This is one reason why people rush to make their RRSP contributions before the Feb. 28 deadline and it is one of the big myths about RRSP contributions.

The Canada Revenue Agency rarely gives you something for nothing. An RRSP contribution plus the refund is not worth more than the contribution.

Suppose you live in Ontario, earn $75,000 a year and make a $1,000 RRSP contribution.

At that income level your 2021 marginal tax rate is 30 per cent, so your refund will be $300. You seemingly have $1,300 for an investment of $1,000.

But the refund just represents tax that you have to pay when you withdraw the money. Suppose sometime in April when you get your tax refund, you withdraw the $1,000. You’ll pay $300 in tax on the $1,000, leaving you with $700, plus the $300 refund: $1,000.

The only way you come out ahead is if in retirement when your RRSP has been converted to a Registered Retirement Income Fund (RRIF) you draw down your RRIF at a tax rate that is lower than today. It often is for people in retirement.

And if over time your $1,000 doubles to $2,000, so does your tax liability.

But even with a higher tax bill later, the smart thing to do with your refund is put it back into your RRSP.

Sure you pay some tax, but the compounding power of interest leaves you with a larger investment. Compounding is something that Albert Einstein called the eighth wonder of the world.

Adam Mayers writes about investing and personal finance. He is a contributor to the Globe & Mail’s Globe Advisor and a contributing editor to Gordon Pape's Internet Wealth Builder newsletter. Adam was Business Editor and investment columnist at The Toronto Star and is the author of six books.

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