Save Now, Pay Later

In my post where I transferred $5,000 of Visa balance to my zero interest MasterCard so I can use the saving to invest in my RRSP, I came across this very interesting question from Rob. Normally I answer questions right in the comments but this one requires more explanation than a few simply paragraphs. The answer also makes for a good blog post. One method I used to get new post ideas is by reading the comments left by readers. This is something to look at next time you’re wondering, “What should I post about today?” Anyways, on to Rob’s question.

The $5000 you put into a RRSP, eventually you have to take it out. 30 years from now it will be worth $87,000, which implies $30,000 of it belongs to Revenue Canada one way or another (direct withdrawal or upon death), was it worth to keep $2000 in tax to pay $30,000 later?

Was it worth it to save $2,000 in taxes now only to pay $30,000 later? Well, let’s look at it. You may end up paying $30,000 (I say may because there are ways to get the money out without paying tax on it) but you also have $87,000 instead of $5,000, which is still a gain.

To suggest that I shouldn’t invest because I’ll end up paying more taxes on the gain is like telling someone not to get a higher paying job because he’ll end up paying more income taxes – it doesn’t make sense when you think it through. Someone who makes $100,000 a year will pay more taxes than someone who makes $50,000 a year but the bottom line is the person who makes $100K still makes more even after the taxes. If that were not the case, then no one would try to move up to a higher paying job.

The same hold true for investments. Would you rather pay $2,000 taxes on $5,000 or pay $30,000 taxes on $87,000? In the first case, you’re left with $3,000. In the second case, you’re left with $57,000. Which would you rather have? The answer seems pretty simple to me. Yes, you pay more taxes but you still net more.

As I have stated earlier, there are ways to get the money out of the RRSP with little or no tax impact. In that case, the question then becomes, would you rather have $3,000 or $87,000?