The investor who saves for retirement in an RRSP will come out well ahead financially compared to one who saves in a non-registered account according to a report released today by RBC Financial Group Economics.

“Increasingly investors are questioning the value of saving in an RRSP, versus saving in a non-registered account,” said the report’s author, Derek Holt, assistant chief economist with RBC. “But as this study shows, the typical investor will be better off sticking with the RRSP.”

“The argument used against the RRSP is that in retirement an investor will pay less taxes with a regular, non-tax sheltered account because income drawn from it is taxed at a lower rate. While income from an RRSP is taxed as regular income at the investor’s full marginal tax rate, income from a non- registered account takes a capital gains tax hit of only 50%,” said Holt.

According to Holt’s research there are two obvious and fatal flaws in this argument, “First, it ignores the tax implications of choosing between the two vehicles while saving in the years prior to retirement; second, it ignores the basic concept of the time value of money.”

The report, available online at www.rbc.com/economics/market/pdf/rrsp03.pdf, concludes that the RRSP investor would be much better off — to the tune of huge tax savings netted out over the full investment life cycle, a portfolio that is hundreds of thousands of dollars larger at retirement and considerably higher after-tax retirement income.

To demonstrate these points, the report considers two hypothetical individuals who are identical in all respects except that one, Joe, saves in a non-registered account and the other, Jane, saves in an RRSP. In order to examine who wins at the end of the day, the implications of the two approaches are examined over two periods: the pre-retirement savings years and the post-retirement draw down period.

“Over the entire cycle of pre-retirement saving and post-retirement draw down, Jane pays $104,000 less in taxes than Joe. Jane comes out ahead because the higher taxes she pays in retirement are lower than the higher taxes Joe pays during his pre-retirement saving years, especially since taxes paid in retirement are more heavily discounted than taxes paid in earlier years,” said the RBC report, Why you should save for retirement in an RRSP instead of a non-registered account.

The report uses these assumptions for the two individuals:

  • Both are 35 years of age, have 30 years to save for retirement and wish to be prepared to live 30 years after retirement;
  • Both wish to consume all of their wealth over the retirement period, leaving nothing to their estate;
  • Both expect to remain in the same tax bracket — 40% — and choose to invest strictly in non-dividend paying equities;
  • Both expect to earn identical rates of return at a modest inflation-adjusted rate of six% compounded annually, and believe inflation will rise two% a year;
  • Both expect realized capital gains equal to about five% of total capital gains each year resulting from regular portfolio turnover; and
  • Both will save $5,000 per year in each of the 30 years before retirement. This is the only saving they will do.