Every year around this time, there’s a big marketing push to open up and contribute to a Registered Retirement Savings Plan (RRSP). And for good reason. RRSPs are still one of the best retirement saving and tax-deferral opportunities available for Canadians, even though a majority of us do not use them to the max. So to help you make the most of an RRSP, here are 10 rules to follow.
1. Contribute. That sounds simplistic, but as the saying goes, “you can’t win if you don’t play.” Basically, an RRSP lets you contribute 18% of “earned income” every year to a pre-set maximum. For 2012, the maximum contribution limit was set at $22,970. And the last day to make a contribution for the 2012 tax year is March 1, 2013.
2. Pay yourself first. If you can’t contribute your maximum in a year, contribute as much as you can. Make monthly contributions – the sooner you start tax-sheltered compounding in your RRSP, the better. Start off with small amounts, gradually increasing as your salary rises. Preauthorized or automatic payment plans are an effective way to ensure regular contributions.
3. Start young. The sooner you start, the more effective the tax-sheltered compound growth within an RRSP, and the more you’ll have when you’re ready to retire.
4. Use contribution room. You can carry forward any unused contribution room (that is, amounts you did not contribute to your maximum in a given year) from each year from 1991 on and use them to expand your contribution in future years. If you’ve made a large contribution in a year, you don’t have to apply the deduction all at once – you can spread it out and use it in future years.
5. Reinvest your refund. You get a tax deduction on your contribution for a given year. If that generates a tax refund for the year, don’t blow it. It’s like found money, so reinvest in your RRSP to expand your contribution and generate another tax refund next year.
6. Don’t break open the piggybank! Your investments grow tax-free inside an RRSP. You don’t pay tax until you withdraw funds from your RRSP at retirement, and then you pay at your full marginal rate, which is typically lower than it is in your peak earning years. If you withdraw funds for an RRSP in your peak earning years, you’ll pay tax at your top marginal rate, and lose the benefit of all that tax-sheltered compound growth.
7. Invest wisely. For many people, an RRSP will be their only source of retirement income apart from the Canada Pension Plan. While RRSP-eligible investments include everything from individual stocks to bonds to mutual funds and exchange-traded funds, it’s not the place to speculate on junior mines or high-tech start-ups. Moreover, 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.
8. Know your limits. Most of us tend to overestimate our capacity to deal with market volatility and take investment losses. Be realistic about your own tolerance for risk (and ignore what your neighbor, uncle, or barber thinks). Then allocate your RRSP assets accordingly. If you don’t know what that means, it might be time to get some help from a qualified advisor.
9. Use caution with RRSP loans. Loans are sometimes used to top-up RRSP contributions. But use these only if you can apply any refund that’s generated to paying off the loan or if you are certain you can pay off the loan over a short period of time. Be careful you don’t get into a cash-flow bind with an RRSP loan.
10. Select the right maturity option. When you retire, you can withdraw RRSP funds in a lump sum (and pay a huge tax bill), roll over into a Registered Retirement Income Fund (RRIF), or purchase an annuity (you must collapse your RRSP in the year you turn 71.) There are pros and cons to each of these, and it’s best to discuss them with an advisor.
Robyn Thompson, CFP, is the founder of Castlemark Wealth Management, a boutique financial advisory firm specializing in wealth management for high net worth individuals and families. Contact her directly by phone at 416-828-7159, or by email at email@example.com, for a confidential planning consultation.
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The foregoing is for general information purposes only and is the opinion of the writer. No guarantee of investment performance is made or implied. It is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. Please contact the author to discuss your particular circumstances.