Canadian taxpayers now have less than 30 days to top off their registered retirement savings plans (RRSP) for the 2023 tax year.

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Why investing within an RRSP makes sense for tax purposes no matter what you believe Back to video

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This year’s RRSP contribution deadline falls on Feb. 29, which is the 60 days after Dec. 31. The deadline is important if you want to be able to claim the deduction on your 2023 tax return, which is generally due April 30.

The amount you can contribute for the 2023 tax year can be found at the very bottom of your “RRSP deduction limit statement” on your Notice of Assessment. It can also be looked up online using the Canada Revenue Agency‘s My Account. For 2023, the RRSP deduction limit is $30,780 or 18 per cent of your 2022 earned income, whichever is lower, subject to any pension adjustment from your employer, plus any unused RRSP deduction room carried forward.

Each time I write about the benefits of RRSP contributions, I receive a barrage of angry reader e-mails trying to convince me of the folly of RRSP investing, and how I’ve been hoodwinked by the financial services industry into recommending an unsuitable product that only causes tax pain later on when the funds are withdrawn.

Many of these readers suggest they would have been better off focusing their investing efforts on non-registered blue-chip, dividend-paying stocks with long-term growth potential. After all, they argue, Canadian dividends are favourably taxed due to the dividend tax credit, and, if the stocks do well, the ultimate profit will be taxed as a capital gain, of which only 50 per cent is taxable.

But what these readers don’t fully appreciate is that the returns from RRSP investing are tax free, not simply tax deferred. Yes, there’s tax later on when you withdraw the funds, but in the meantime, you’ve enjoyed tax-free returns on the RRSP investments. Don’t believe me? Let’s illustrate with an example.

Tess is an Ontario resident who earns $90,000 annually. Her marginal tax rate is about 30 per cent today, and she expects to be in the same tax bracket when she withdraws RRSP (or registered retirement income fund) money in retirement. Suppose she contributed $10,000 of her employment income to an RRSP. If on Jan. 1, 2024, she invested in a stock that had a five per cent dividend yield, her RRSP by the end of the year would be worth $10,500, assuming no stock appreciation. If she were to then cash in her RRSP, she would net 7,350 ($10,500 less tax of 30 per cent).

Now suppose, instead, that Tess was looking to benefit from the preferred tax rate on Canadian dividends rather than have them fully taxed when withdrawn from her RRSP. She uses $10,000 of her employment earnings to invest in the same five per cent dividend-paying stock in a non-registered account. Because the funds aren’t going into an RRSP, Tess won’t get a tax deduction for the $10,000, and she would therefore have to first pay tax of $3,000 ($10,000 times 30 per cent) before investing the net amount of $7,000.

The dividend yield of five per cent would result in 2024 dividends of $350 (five per cent of $7,000), and Tess would pay combined federal/Ontario tax of approximately $20 on those dividends, the low tax primary attributable to the federal and Ontario dividend tax credits. If we again assume no capital appreciation, Tess would only net $7,330 ($7,000 + $350 – $20) on an after-tax basis versus the $7,350 she would have netted on her RRSP.

At first glance, this result may seem counterintuitive, since with the RRSP, Tess is effectively paying tax on the dividend income earned in the RRSP at full marginal rates (assumed to be 30 per cent) when it’s withdrawn, versus her combined federal/Ontario marginal tax rate on eligible dividends of about six per cent when those dividends are earned in a non-registered account.

But remember that her “net” investment in a non-registered investment is lower because she had to pay 30 per cent tax on her employment income before she could invest those funds. As a result, her dividend income is also lower.

Another way to look at it is that when you contribute to an RRSP, you are effectively getting a tax-free rate of return on your net after-tax RRSP contribution (assuming your tax rate in the year of contribution is the same as the rate in the year of withdrawal). In our case, Tess’s net (after-tax) RRSP contribution was $7,000, which at a five per cent return yields $350 of effectively tax-free dividends.

I would also argue that even if your tax rate is higher in the year of withdrawal (or, ultimately, in the year of death) than it was in the year of contribution, you may still be better off with an RRSP investment than non-registered investing.

The benefits of having additional capital for investment can outweigh the additional tax cost of a higher withdrawal tax rate if the time period is long enough. Ultimately, this will come down to your tax rates, the rate of return on the investment, the number of years of compounding available and the types of investment income (for example, interest, dividends and capital gains) you earn.

Jamie Golombek, FCPA, FCA, CFP, CLU, TEP, is the managing director, Tax & Estate Planning with CIBC Private Wealth in Toronto. Jamie.Golombek@cibc.com.

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