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Investment Basics

Retirement Savings Plans: More Than Just A Tax Break

Usually we connect RSP's with an immediate tax deduction, but the long-term benefits of accumulating assets in a tax-sheltered plan may be just as great as the short-term deduction.

Your annual RSP contribution is based on your previous year's earned income minus a pension adjustment for any benefits you accumulated in a pension plan or deferred profit sharing plan from your employer. Your RSP deduction limit is listed on the Revenue Canada Notice of Assessment you received following your last year's tax return.

When you contribute to an RSP you can claim an equivalent deduction from your income before calculating your tax payable.This immediate deduction is very worthwhile, especially if you use the tax saved to make an RSP contribution for next year or pay off after-tax debt such as your mortgage.

However, RSP investments also accumulate within the plan tax-free. The longer your money stays sheltered from the taxman, the greater the earning power of your investment. The most powerful benefit of an RSP is this tax-free accumulation.

Compare taxed and tax-free investment returns. Investors having a marginal tax rate of 40% who invest $1000 per year for the next 30 years at an average 10 per cent annual return, and pay tax as the profits are earned, will accumulate $57,435.

If the same investor contributes $1000 per year to an RSP for the next 30 years, earns an average 10 per cent return, then pays all taxes owing, $108,696 will be left. The investment has almost doubled when the income was tax-sheltered in an RSP.

The real power of an RSP is this compounding effect over a long period of time. Without the tax in the example above, it's like adding 4% to your average annual rate of return, certainly nothing to sneeze at. With a high rate of return, RSP contributions early in your life can go a long way toward providing for your retirement.

At any age, RSP contributions are one of the very best investment strategies. You always get the tax deduction, and you always have your investment compounding tax-free.

Another good strategy is making "spousal" RSP contributions. The higher-income spouse contributes to the lower-income spouse's RSP. The higher-income spouse receives the RSP tax deduction. However, when it's time to draw the RSP contributions out, they go to the lower-income spouse at a lower tax rate. This is one of the few allowable ways to split income and is highly recommended.

Mutual funds specify objectives in their prospectus to investors. Some aim for growth, some for steady income, some for preservation of capital. Talk to your investment adviser about your investment objectives and capacity for risk. Your adviser can help you find the RSP investment fund that is right for you.

But remember, start today. The sooner you contribute, the sooner you will lower today's taxes and begin accumulating your investment tax-free.

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