Every so often, you may hear the opinion that saving in a non-registered account is a better way to fund your retirement than investing in mutual funds in a Registered Retirement Savings Plan (RRSP).

The claim focuses on the tax that’s payable when you withdraw funds for retirement income. All RRSP or Registered Retirement Income Fund (RRIF) withdrawals are taxed as income at your marginal tax rate. With a non-registered account, any withdrawals that involve selling equity investments are taxed more favourably, only triggering tax on capital gains.

However, even though non-registered equity investments offer a tax advantage, you still come out ahead with an RRSP. It’s all because you can make greater contributions in an RRSP with your available investment dollars than you can in a non-registered account. Here’s an explanation.

The pre-tax dollar advantage

RRSP contributions are made with pre-tax dollars. So, if someone is able to dedicate $12,000 of their pre-tax income toward retirement savings, they can contribute the $12,000 to mutual funds in their RRSP. Say another individual is also able to put $12,000 of their pre-tax income toward their retirement, but they choose investments in a non-registered account. That $12,000 is taxable income, so if they have a 35% marginal tax rate, they pay $4,200 in tax and now only have $7,800 to invest.

Thanks to larger contributions with your available investment dollars, an RRSP can grow to a greater total value than a non-registered account. You can receive more retirement income than you would from non-registered investments, even after the withdrawals are taxed.

More RRSP benefits

Having an RRSP encourages you to save every year, as you reduce your taxable income by the amount you contribute. You’ll also have the discipline not to touch your savings before retirement, since you would pay tax on withdrawals at your marginal rate. When you reach age 65, you can use income from your RRIF to benefit from pension income splitting.