A tax accountant once told me about how I shouldn’t put my money in an RRSP. Apparently, I was too young to invest in it. Then he educated me about how I can get taxed if I decide to take out my money in an RRSP before retirement.
The first round of taxing happens as soon as I take the money out.
The second round of taxing happens when I pay my annual tax for the year. Why? That money I withdrew is considered as part of my income. The higher your income, the higher the taxes you have to pay.
Now that sounds like a double whammy. It puts RRSP in a bad light.
But as I’ve learned more about it, I realized how powerful RRSP is when it comes to saving you money from paying your annual taxes!
As I mentioned earlier, the money that goes in and out of your RRSP money is considered to be an income. When you put in money, you reduce your income. When you take out money, you increase your income.
Now, that money you put in your RRSP will earn some interest. And it’s “tax-deferred,” meaning, you are not going to get taxed on your earnings. Taxing happens only when you take it out (because, again, it is considered an income).
Simply put, RRSP provides you with double-benefit:
- Reduces the annual tax you have to pay, thus, increasing your tax refund for the year.
- You don’t pay taxes on the “income” you get from the money you put in it.
That being said, why wouldn’t I invest in an RRSP?
Also, run the numbers. Find out how much money you are saving from reducing your taxes. You’ll realize why you didn’t get started right away.
One last note: RRSP is for retirement. It is NOT an emergency fund. Therefore, you shouldn’t even think about taking it out until you retire.
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