The growth of an RRSP is determined by its contents. Simply having money in an RRSP is not a guarantee that you may retire comfortably; however, it is a guarantee that the investments will compound without being taxed, as long as the funds are not withdrawn.
As mentioned earlier, tax-free growth is one of the biggest advantages of RRSP contributions. Here we show you just how powerful both tax-free contributions and tax-free compounding can be, by contrasting Joe, our RRSP contributor, to Jane, our RRSP non-contributor.
The examples below make several assumptions about Joe and Jane:
In our first example, we've compared the amount of income tax paid by Joe and Jane.
As you can see, the difference is staggering: Joe's income tax is significantly lower than Jane's. Contributing to an RRSP reduces tax liability not only because these contributions can be deducted from the contributor's earned income, but also because the returns on these investments are exempt from any capital gains tax.
We've charted the difference in size between Joe and Jane's portfolios.
As the graph shows, the difference between the two portfolios is huge. In fact, given the assumptions we've made, it amounts to more than $3 million! There's a very clear difference between the way money grows when it is sheltered from taxes and the way it grows when it is taxed every year. In an RRSP, the money that would have been spent on taxes is actually invested back into the portfolio, rather than being taken out of the portfolio and given to the government.
Don't get overwhelmed or distracted by the different assumptions made in these examples. The core idea you should take away from this section is simple - contributing to an RRSP benefits you in two ways: 1) it reduces the amount of income tax you must pay each year, and 2) it allows your investments to compound tax free (a huge advantage).
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