Still the most effective retirement savings plan there is
The Registered Retirement Savings Plan (RRSP) is still the most effective retirement saving and tax deferral vehicle available to Canadians. Because it’s such a powerful savings tool, it makes sense for everyone to open a plan a contribute to it regularly. This year, the deadline for RRSP contributions that will be eligible for a 2017 tax deduction is March 1, 2018.
Your maximum contribution to an RRSP is calculated as the lesser of 1) 18% of your earned income from the prior year, or 2) the maximum contribution limit for the tax year, or 3) the limit after deducting company pension plan contributions. “Earned income” includes your salary, but may also include alimony payments and rental income, but not investment income.
The maximum contribution limit for 2017 is set at $26,010. It increases to $26,230 for 2018.
Looking for ways to make RRSP contributions? Here are some favourites:
Automatic deposits. Arrange with your bank or your employer (if they’ve set up a group RRSP) to automatically deposit funds to your RRSP with every paycheque. Contributing through the year gets your money invested and compounding that much sooner.
Severance payments. If you received a severance payment in 2014 (and you haven’t already blown it on something), use it to make an RRSP contribution. That way, you’ll shelter some or all of the severance amount from income tax.
Inheritances. You may have received a bequest during the year. If it’s a substantial sum, use at least some of it as an RRSP contribution. Bequests themselves are generally not taxable as income, but any investment income from that bequest is. So put some of it into an RRSP, where investment growth is tax-sheltered until your RRSP matures.
Contributions in kind. If you have qualifying investments outside an RRSP in a non-registered account, consider transferring some of them to an RRSP. Their current value will be deemed to be the contribution amount for tax purposes. If you make this type of contribution, keep in mind that there will be a “deemed sale” of the asset, and 50% of any capital gain may be taxed. However, the upside is that you’ll get a tax deduction on 100% of your contribution. To make contributions in kind, you’ll need a brokerage account or have a self-directed RRSP that lets you pick and choose your own investments.
Borrowing to invest in an RRSP. The biggest downside to borrowing your RRSP contribution is that you are leveraging your investment. It makes no sense to put borrowed money into a safe, interest-bearing investment like a GIC, because it earns less than the cost of your loan. But if you invest in equity investments, either directly or through a mutual fund or ETF, you run the risk of magnifying any losses that may occur. In other words, the value of your investment may end up being less than the value of your loan – never a good situation!
Another minus is that an “RRSP loan” is still a loan – a debt with interest payable. And you must pay the lender (usually your friendly neighbourhood bank) the money when it’s due, regardless of what happens to your RRSP investment or anything else. People who jump into RRSP loans without thinking about the effect on their cash flow are usually in for a rude awakening.
Carry forward contribution room
A contribution to an RRSP gives you a tax deduction for the year of the contribution. This may reduce your overall tax bill, or even result in a refund.
Many people are unable to make the maximum RRSP contribution in a given year. If so, the rules let you carry forward the missed contribution indefinitely as extra contribution room for future years. Your unused contribution limit is also shown on your CRA Notice of Assessment.
The carry-forward feature may be especially useful for those who expect to be in a higher tax bracket in future years.
The sooner you start tax-sheltered compounding in your RRSP, the better. Start off with small amounts, gradually increasing as your salary rises. Remember the magic of compounding. Even a $500 monthly investment compounded monthly at a relatively conservative rate of 6% will grow to $500,000 in 30 years.
You can also increase your contribution in a given year by using “contribution room” you’ve carried forward from previous years (the contribution you didn’t make last year, for example). And you should also reinvest your tax refund. It’s found money.
Besides its tax-deferral features, another big advantage of an RRSP is that it may hold a wide variety of investments, including mutual funds and exchange-traded funds (ETFs). Here’s a quick list of what the CRA says are qualified RRSP investments. The CRA website has more details.
Bonds. Federal, provincial, municipal government bonds are eligible. Bonds of publicly-traded companies are also qualified investments.
Exchange-listed securities. This encompasses common and preferred shares, exchange-traded funds, closed-end funds and other securities that are traded on designated stock exchanges in Canada or other countries. This also includes limited partnership units and royalty units. Canadian and U.S. stock exchanges are listed as designated exchanges. However, “over-the-counter” trading systems are not eligible.
Exchange-traded funds (ETFs). ETFs traded on designated stock exchanges are qualified RRSP investments.
Mutual funds. Canadian mutual funds are eligible – and there are thousands of these to choose from.
Options. Covered put and call options on qualified stocks are eligible as RRSP investments. Note, though, that I wouldn’t recommend options for everyone. These are specialized types of investment products, and can be quite risky if you don’t know exactly what you’re doing.
Money or cash deposits (including foreign currencies under certain circumstances).
GICs. Guaranteed Investment Certificates are, of course, qualified RRSP investments.
Other. Annuities, mortgages, certain shares of small business corporations and venture capital corporations can be put in an RRSP. You may also put money into investment grade gold and silver bullion, coins, and certificates. But again, I wouldn’t recommend rushing out and putting your RRSP retirement fund into precious metals or venture capital corporations, for example, without some serious advice from a qualified adviser.
Know yourself and invest wisely
For many of us, an RRSP is our only source of retirement income apart from the Canada Pension Plan. And while you can invest in just about every type of asset class, an RRSP is not the place to speculate on junior mines, high-tech start-ups, commodities, or other risky and volatile assets. Remember, tax benefits like the dividend tax credit, the capital gains tax exemption, and the ability to offset losses against gains are lost within an RRSP.
Aside from not contributing to an RRSP at all, the RRSP investment choice is where most people go astray. Most of us tend to overestimate our capacity to deal with market volatility and take investment losses. So be realistic about your own tolerance for risk. Work with an objective financial planner to allocate your RRSP assets according to a plan determined by your personal goals and a realistic assessment of your tolerance for risk.
Speak with your financial advisor or qualified planner about more complex RRSP contribution ideas, such as contributions in kind or RRSP loans.
© 2018 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited. This article is for information only and is not intended as personal investment or financial advice.