RRSP Investing: Striking a balance between spending and saving
No matter which stage of life you’re at, you probably have competing demands for your money. Whether it’s paying down debt, saving for a down payment, funding your children’s education or making home renovations, there’s always something else to spend on.
But even if you feel there’s no more money left, you can still find pain-free ways to save for your future, and in particular, your retirement years.
This guide is designed to provide an overview of Registered Retirement Savings Plans (RRSPs). It will review the many advantages they provide, including tax benefits, a wide range of investment options and most importantly, the ability to ensure that you have enough income to enjoy a comfortable retirement.
With the help of your financial advisor, you’ll gain peace of mind when you choose registered investments as the foundation of your long-term investment strategy. Your advisor can recommend investments that will help your RRSP grow with your needs, while reflecting your comfort with risk.
More than 50 years ago, the federal government introduced RRSPs to encourage Canadians to plan and save for their own retirement instead of relying solely on public pension plans.
The RRSP has evolved over the last half century, giving investors increased incentive to save for their retirement.
Most fundamentally, the growth on investments inside an RRSP is tax-deferred, meaning you don’t immediately pay tax. Any interest, capital gains or dividends earned will compound tax-deferred. Money is taxed – as ordinary income – only when you remove it from the plan. In addition, you get a deduction from the annual taxable income you earn for every dollar you contribute to your RRSP.
An effective way to save for your retirement
RRSPs provide a significant opportunity for Canadians to save and investors generally recognize them as the best way to save for retirement.
Public pension plans – Old Age Security and Canada Pension Plan – together provide a maximum of $19,956 annually to individuals aged 65 and older.
Also, unless you participate in an extremely generous plan, a corporate pension plan alone cannot meet your income needs throughout retirement.
Key benefits of an RRSP
- Investments compound tax-deferred as long as they remain in the plan
- Choose your investments from a wide range of options
- Contributions are tax-deductible
Frequently asked questions
The deadline falls 60 days after the end of the year. If that day falls on a weekend, the CRA may extend the deadline to Monday.
You can contribute up to 18% of your earned income to a maximum of $25,370 in the 2016 tax year (minus pension adjustments from your company pension plan) in addition to unused contribution room from previous years.
Your Notice of Assessment from the CRA will state your maximum contribution room for the current year. If you need to double check, call the CRA at 1-800-267-6999.
Earned income includes salaries, self-employment income, taxable maintenance and alimony payments, and net rental income. It does not include income from pensions or investments. Speak to your financial advisor about other types of income that may be eligible.
If you don’t contribute the maximum amount that you’re allowed, you can carry forward the unused portion indefinitely. Your Notice of Assessment will show your unused RRSP contribution room.
Over-contributions are subject to penalty fees. Where over-contributions exceed $2,000, you will be assessed a 1% per month penalty tax until the excess is withdrawn or additional contribution room becomes available.
You can hold mutual funds, equities, bonds, cash and a variety of other investments in your registered plan. Speak to your advisor to ensure you do not own prohibited investments.2
The 2005 Federal Budget eliminated the foreign property limit for tax-deferred retirement plans. You are no longer restricted to holding up to 30% of foreign investments in your portfolio.
Borrowing money to invest can be an effective way to maximize RRSP contributions. One strategy to consider is to apply for your loan in December, defer funding to February (in time to meet the RRSP contribution deadline), defer your first repayment to July and use your tax refund (typically received between April and June) to reduce your loan balance. Speak to your financial advisor to see if this is a suitable investment strategy for you.
The higher income earner normally makes the contributions on behalf of his or her spouse. The contributor, normally the higher income earner, would claim a tax deduction for the contribution, and withdrawals would be taxable to the lower income spouse (provided contributions have remained in the plan for at least three years).
You can withdraw from your RRSP but the amount you withdraw will be included in your income as fully taxable ordinary income. You will have to pay withholding tax when you withdraw (note: there are withdrawal restrictions if you have a locked-in RRSP). You might also have to pay additional tax on the withdrawal when you file your tax return for the year with credit for any withholding tax previously withheld.
The government offers two programs where you can take money out for your RRSP without tax provided the amounts are re-contributed to the RRSP over time. The Home Buyers’ Plan (HBP) lets a first-time homebuyer withdraw up to $25,000 for the purchase of a new home. The Lifelong Learning Plan (LLP) lets a student (or a spouse) withdraw $10,000 per year up to $20,000 to fund full-time education or retraining. Repayments under the HBP must occur over a 15-year period. Repayments under the LLP must occur over a 10-year period.
Generally, no. The federal government requires financial institutions to calculate, to the extent possible, withholding taxes on RRSP withdrawals on a cumulative basis. If you make five separate requests for withdrawals of $5,000 or less, each withdrawal may be subject to an escalating withholding tax to a maximum of 30% (31% for Quebec residents).
You must wind up your RRSP by the end of the calendar year in which you reach age 71, typically by way of transfer to a Registered Retirement Income Fund (RRIF). However, you may convert to a RRIF at any time.
Don’t wait for your financial institution to tell you that it’s time to convert. If you don’t choose a RRIF (or annuity) by the end of the year in which you turn 71, the financial institution that holds your RRSP could cash it in and send you the cash less any income taxes which must be withheld. Where this occurs, the total value of your cashed-in RRSP will be added to your income for the year. It’s up to you and your financial advisor to avoid a big tax bill at the end of the year.
1. Source: Service Canada. Current to 2016.
2. Generally, a “prohibited investment” will include debt of an annuitant (other than certain insured mortgages) and investments in entities in which you or a related person has a significant interest (generally 10% or more) or with which you do not deal at arm’s length. If you hold a “prohibited investment” a 50% penalty will be applied to the fair market value of the investment at the time it was acquired or became prohibited. The penalty will be refunded if you dispose of the investment by the end of the year following the year it was acquired or became prohibited.
3. Using borrowed money to finance the purchase of securities involves greater risk than a purchase using cash resources only. If you borrow money to purchase securities, your responsibility to repay the loan and pay interest as required by its terms remains the same even if the value of the securities purchased declines.
Call your financial advisor for more information on RRSP investing with Mackenzie Investments.