How much you can contribute, what you can invest in
Among the most common questions financial advisors are asked at this time of the year are, “How much can I contribute to an RRSP?” and “What can I invest in?” Registered Retirement Savings Plans are still the best individual tax deferral vehicle available for retirement savings, so it makes sense to review the contribution limits and qualified investments.
The simplest way to see how much you can contribute to your RRSP is to check your last Notice of Assessment from the Canada Revenue Agency. Your personal allowable RRSP contribution limits for the year appear in a special box at the bottom of that Notice. But if you’re going to contribute, and you haven’t set up an RRSP yet, you’d better get a move on. For the 2016 tax year, you have until March 1, 2017, to make a contribution, provided you were not over the age of 71 in 2016.
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 2016 is set at $25,370. It increases to $26,010 for 2017.
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.
RRSPs may hold a wide variety of investments, including mutual funds and exchange-traded funds. 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 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.
© 2017 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.