Canadian Taxpayers – Registered Retirement Saving Plans (RRSPs) Explained
The story and example has been retold many times of a son who had taken the time to count up his parents net worth whom it seemed to be strung across town in a myriad of small bank accounts and as well in saving bonds. When the son explained to his father, the net worth of his wealth in total the father exclaimed – “We’re not rich. We never had money”. Father the son explained “Did you ever hear of the power of compound interest? You had the power of compound interest working for you.”
Canadians now have the RRSP (Registered Retirement Saving Plan) season on the way. Indeed few nations on earth allow their citizens such an investment spiff. Put away income at your time of highest earning. Allow it to grow and compound over time, tax free, sheltered of income and growth robbing taxes. The Canadian government is hoping and betting that first of all you will thus have a nest egg to live on and not be dependent on social programs which the government would have to provide to retirees.
This lightens the load for the Canadian government. It provides for a stable base for investment sources – for banks and other financial institutions to have a stable source of long term investment capital for mortgages and long term capital investment. The private investor does pay tax in the end – the government does collect it. However its is down the line when first of all the retiree will generally be taxed at a lower rate than their peak working years and the saving fund will have grown considerably with time and compound interest. Everybody wins so to speak and younger people at that point will benefit by having other people in their communities with money to spend for good and services – providing employment for the then younger generation.
What are the basic rules of Rasps for Canadians? First of all know your limits. Its crucial and the first step to know how much contribution room you have in dollars before sitting down to plan or buy RRSP financial instrument contributions.. This will actually be listed clearly on your last year’s personal tax assessment from Revenue Canada. If you are unsure, or want to verify the amount, there is always a phone number or even an email address to contact the government agency.
Next contribute as much as you feel that you can spare. Remember a dollar saved or contributed is worth more than dollar invested. First there are definite tax savings. Next the money is sheltered from taxable interest. Even if you earned money in the bank or in Canada savings bonds as interest a good portion would go to pay the taxman, at your highest marginal rates. Most people spend close to their limit. If you do not the funds you will not or cannot spend them. An RRSP is a long term savings plan – not a piggy bank. You can withdraw savings in most cases. However you will pay your current high tax rates on withdrawals as if was income. It’s best to leave some savings outside your Registered Retirement Saving Plan.
Contribute early – both early and earlier in the year than most. Contribute early in your life in possible. This way you have the great and wonderful power of compound interest working on your behalf with all its power.
What are the flip side and the negatives about RRSPs? Most people it seems never get around to contributing so this is often the least of most people worries. However two points should come to light. As with any investments you have the choice of risk rewards. If you choose risky investments then pay heed to the risk factor that you are playing with your retirement nest egg. If you are young and have time to recoup any lost capital that is fine. However if you are on the home stretch don’t try to make up for lost time or be greedy.
In the end the summary of Canadians investing for their retirement nest egg through the vehicle of a Registered Retirement Income RRSP plan ahead , save early , save often and contribute as much as you feel that you can.
Shaun Stevens Winnipeg Manitoba Canada St. Boniface Budget StBoniface Economy Hotel
RRSP FAQ:
Question: What is the maximum allowable RRSP contribution in Ontario Canada?
Can I put in as much as I want? Also, if I haven’t put much money into RRSP’s over the past years can I put in for past years?
Answer: The maximum is 18% ($20K max) of your T4 income from last year minus any pension adjustments from an employer sponsored pension plan (if you have one).
As for the past few years, the amount that you did not contribute carries forward. When you filed your income taxes last year, the Notice of Assessment that was eventually mailed to you would have your unused amount. Alternatively, you can call the CRA or check online.
Question: How does a RRSP catch up loan work?
I haven’t maximized my RRSP contributions in the last 6 years. I’m planning to get a loan to catch up. Will my refund be equivalent to the amounts that I would have received if I had made these contributions during those years. Will I get a lump sum or several smaller amounts over a specific period.
Answer: In my opinion, I think you should be careful before you take out a loan to catch up on RRSP contributions. There are several pieces of information you need to consider – at what interest rate is the loan? And what is your marginal tax rate? Go see an independent tax professional (like an accountant). Don’t go to the bank for advise! I’m not a tax expert, but I think the loan idea for the RRSP really works to your benefit if only you can pay it all back in the same tax year.
Question: What can you tell me about opening an RRSP?
I am 25 years old and I am thinking about opening up an RRSP. How does it work? I’ve only heard of it from a financial show I’ve been watching and they say if you invest about $200 in an RRSP a month, in 40 years you could have a huge chunk of cash to retire on.
Answer: The basic concept of an RRSP is that you place money into a segregated fund, receiving a tax deduction for doing so (it’s the same as earning the money tax free) where it accumulates interest of other gains tax free. When you withdraw the money 20, 30, 40 yrs later, you’ll pay tax, but you will often be in a lower tax bracket by then and will thus pay less tax. There are tons of RRSPs around, you can pick and choose. Starting at your age, you can indeed accumulate a large portfolio by the time you’re ready to retire, even with a minimal return. The sooner you start, the better you’ll be in retirement. To use your example of $200 per month, at even a 1% return, you’d have $118,000 40 yrs from now. With a 5% return, it would be $306,000.
Question: What criteria is important when choosing an institution for an RRSP?
Im looking to start an RRSP but so many places are offering different ones. I’m not sure how/who to choose and whether to have more than one RRSP at different institutions, or to have all my investments in just one. Any thoughts?
Answer: Well it depends what kind of RRSP are you looking for: mutual fund, direct investing (stocks).
For funds you’re looking for a combination of performance and management fees. Also pick the bank that will allow you to buy the funds you want if you’re looking solely at bank mutuals. TD has the efunds which have the lowest MER in Canada (0.5%) which are available solely through a TD efunds RRSP.
For direct investing, there is often a $50-$125 annual admin fee. My bank waived mine because I have my mortgage with them.
The CIPF protection is currently $100k per account. So I would be wary of placing more than this limit in one institution.
I have 3 RRSPs at three different institutions. All for different reasons:
#1 ) RRSP for my employers group RRSP plan
#2 ) RRSP direct investing at my bank
#3 ) RRSP directly with a fund company for access to their funds.
Question: Is a spousal rrsp safe from the ups and downs of the economy?
Answer: No RRSP is safe from all ups and downs in the economy if it is invested to earn a reasonable rate of return. That said, it would still be prudent family planning to build a spousal RRSP if your spouses do not have income to build their own. It helps to distribute retirement income.
But you still have to choose investments wisely to hopefully have something close to secure future. You can buy an insured RRSP, a segmented fund investment. The principal is insured at the end of a 10 year period it will not be worth less than at the beginning.
Question: Can anyone give me some ideas to diversify my RRSP to include holdings outside of Canada and the US?
I have about $10K to work with in a self-managed RRSP. I’m comfortable doing Fundamental Analysis of Oil & Gas companies or Mining companies. I’m also comfortable with basic Technical Analysis techniques. I hope to find something that returns 15% or better per year.
Answer: I don’t have specific stock recommendations, but have you looked at iUnits? They’re exchange traded funds that I believe give you exposure to the US market while not violating the foreign holdings rules of RRSP accounts. iUnits are managed by a division of the largest ETF provider in the US (Barclays) and are similar to their US counterparts, iShares. Of course, these aren’t likely to return 15% EVERY year, but they do offer less risk than individual stock holdings.
Question: Does anyone know a formula to calculate how much $ I should put into an RRSP to offset a huge annual CRA debt?
I always end up owing the government between $4000 – $5000 each year in Income Tax. This year I have some extra money and wonder how much I would have to put into an RRSP by the end of this year in order to not owe the government next year. Does anyone know how to calculate this by chance?
Answer: Step 1. How much can you invest and not impair your day to day life? Paying no tax on filing does you no good if you cannot make mortgage payments.
Step 2. Look at last year’s assessment to see how much room you have available.
Step 3. Look at last year’s tax return again and see your federal tax calculation. Look at your top two rates. See how much federal tax you would save if you reduced your income by the amount in the two income levels. Add the provincial factor. For instance if your provincial rate is 50 per cent of federal, the tax savings would be 150 percent of federal.
Or if you care to spend a bit of money, buy a piece of software and plug in the amounts both with RRSP deductions and without. I use Quicktax, you can run a sample tax form, with all this year’s data. It will first of all tell you what you’ll owe this year, and second, it has a handy RRSP tool that let’s you play with sample RRSP contributions to see how much you’d save. In fact, it has a simple suggestion that will tell you exactly what to do in your situation: how much to contribute to have zero owing.
It sounds as though you have two (or more jobs) and not getting enough deducted at source. Check they have the correct TD1 for your situation.
Question: Can I withdraw from my RRSP when my work permit expires?
I’m coming to Canada on a temporary work permit. I’ll be staying for at least 2-3 years during which I’d like to use an RRSP. If I should decide not to prolong my stay beyond that, can I terminate the RRSP when leaving the country without penalty?
Answer: If you leave the money in the RRSP, there should be no penalty. How the RRSP is treated in your country when you draw money from it in the future is another question.
If you take the money out of the RRSP at the end, it will count as income and be added to any money that you earned in Canada.
If the amount you wish to put in an RRSP is less than 5000 a year, you may be better off putting the money in a Tax Free Savings Account. At least you won’t be taxed on the money you take out of it at the end. The only negative thing is you won’t get the deduction for putting money into it.
Another way of thinking it: If you put money in now, you get the deduction. When you take it out later, you’ll get that deduction taken back.
RRSP’s also have a limit based on how much you made the previous year. Assuming you have never worked in Canada before, your RRSP limit would be zero for the first year you work here and you would run a tax liability if you contributed because you would be over contributing.