If you haven’t already contributed to your or your spouse’s RRSP, you may do so up until March 1st for the 2021 tax year. As a reminder, the total allowable RRSP contribution amount for 2021 is the lower of 18% of your 2020 income and $27,830. Unused contribution room from years prior may be carried over, allowing for higher contribution amounts.
The RRSP has gained an unfortunate reputation for being somehow less tax efficient compared to the Tax-Free Savings Account (TFSA). This is a bit of a misnomer as, in most cases, the resulting after-tax outcome is actually the same or better with an RRSP. Investors are required to start drawing taxable income from their registered accounts upon turning 71 years of age, which is why RRSPs are considered tax-deferred (as opposed to tax-free) vehicles. However, the interest, dividends and capital gains generated in the account are indeed non-taxable. RRSP contributions are effectively made with pre-tax dollars, as the contribution itself reduces one’s taxable income at that point in time. This differs from TFSA contributions, which do not provide a tax deduction upfront and therefore are made with after-tax dollars. Fast forwarding to retirement, provided investors have either the same or lower marginal tax rates from when they made the contributions, the RRSP will render results that are just as tax efficient or better than the TFSA. My colleague, Jason Reed, provided an excellent illustration of these scenarios in his QV Update from February 22, 2019, which can be viewed here.
Simply put – if you believe your marginal tax rate will be the same or lower in retirement, it makes sense to favour an RRSP. When initiated at an early age (age of majority), and with continual re-investment of the tax refund generated by the tax deduction, this approach could allow for up to 53 years of un-interrupted, tax-free compounding. Maximizing contributions in both types of accounts is generally ideal in most cases if one has the means to do so.
So far we have touched on the mechanics of contributing to an RRSP. However, it also matters how one invests within their RRSP. It is not uncommon to hear of people making RRSP contributions in order to get the tax deduction, but not actually investing the cash within the RRSP. In order to truly exploit the tax-free benefits of a RRSP it is beneficial to invest in quality companies that have a strong track record of compounding growth through dividends and capital gains. Highlighted below are a couple of QV’s holdings that fit these criteria.
Alimentation Couche-Tard (ATD.b) has been a powerhouse in terms of growing shareholder capital. If left alone to compound uninterrupted, an initial investment of $100,000 in 1999 would be worth over $11 million in 2021, representing a compounded annual growth rate (CAGR) of 24.2% per year (assumes dividends are reinvested annually). Behind that outstanding growth is a solid management team that has led the company into a leading convenience proposition in multiple geographies with a prudent capital structure. Our strong outlook for the company includes continued topline growth.
Source: S&P Capital IQ
Another heavy hitter is Stella-Jones (SJ). For what some may deem as an unexciting business, the company has generated an abundance of shareholder value. With a CAGR of 23% per year, an investment of $100,000 in 1999 would be worth over $9 million as of 2021. The company enjoys a strong market share in the North American utility pole and railway tie business, while also benefiting from cyclical periods of strength in residential lumber demand. With stable recurring maintenance revenue and potential acquisition opportunities, the outlook remains attractive for continued growth.
Source: S&P Capital IQ
Holding a diversified portfolio of these types of companies within a tax-sheltered vehicle such as a RRSP can be quite powerful over time. That said, it is important to acknowledge that with exceptional tax-free growth and maximised contributions, some people may attract a higher marginal tax rate in retirement and other strategies may need to be considered. It is important to seek professional guidance in order to balance both investment goals and tax efficiency. Please contact your advisor to discuss your unique situation.