Oh yea, it’s that time, and you thought I would forget, that I wouldn’t mention them.
Well, from my recent round of trips, I’ve realized that people STILL don’t understand RRSPs, even though advisors have done a great job in explaining them. I believe the public continuously need to be reminded about why they did these things with four letter in them
So, here’s my stab at it.
Firstly some rules and statistics
Changes for 2007 tax year:
- Maximum RRSP contribution is lesser of 18% of earned income or $19,000
- Pension splitting for seniors is allowed
- Deadline for RRSP conversion changed from age 69 to 71
QUICK FACTS
- Number of Canadians who contributed to an RRSP in 2006: 6.2 million
- Median contribution: $2,730
Source: Statistics Canada
The notes below are based on discussions with the public on RRSPs, they’ve been collected based on the most popular questions
Since their introduction in 1957, the RRSP has been the cornerstone of millions of Canadian retirement plans.
The concerns around the stock market investors in early 2008 have done nothing to create a calm investing climate as Canadians ponder where to put this year’s RRSP contribution. This can be seen by the huge amounts of money being put into GICs, Money Market Funds etc. As you’ve probably noted from previous writings, I believe in the Fear and Greed scenario - and that is as Buffet says “Be Greedy when people are Fearful, and Fearful when people are Greedy” and this panic rush to Money markets and GICs tells me that investors are Fearful - so guess what, I’m a Greedy.
Another thing pointed out by David Dreman was that there are two types of people a) The Wealthy and b) the Not Wealthy.
There’s more people that are not wealthy. And the reason they are that way is because of their decisions in investing etc. They made poor decisions and that’s why they are not wealthy So, if you want to not be in that class - don’t follow what they do. Since they are the masses - don’t follow the masses, don’t read what the masses read ( the papers), don’t listen to what the masses listen to, don’t watch what the masses watch (CNBC, ROBTV, BNN etc). Instead do what the wealthy, Which is virtually the opposite of the masses - So, while the “masses” are putting their RRSPs into money markets, and GICs, waiting till the market “will recover” - the smart investors are out their adding to their portfolios with good investments - Remember Warren Buffett, has recently added to his portfolio by buying into Swiss Re and Kraft, and he did it just as the markets were falling.
However, if this year is like most, only about a quarter of us will actually make any RRSP contribution at all. That’s a shame because the RRSP is, for most Canadians, a pretty amazing savings vehicle. People in other nations drool over the tax benefits and wonder why more of us don’t take advantage of it. An article in Forbes.com (headlined “Canadians eschew billions in free money”) pointed out that, despite the immediate tax break and the tax-free compounding in RRSPs, Canadians have only contributed seven per cent of what they could. “The government offers them billions of dollars of free money and they turn their back on it,” the author marveled.
Questions and Answers on RRSPs
Q - Why should I ‘RRSP’?
A- There was a time when financial institutions used to scare people into making RRSP contributions by showing how much they’d need to save to have a secure retirement. The problem was, the amounts were so large that some people threw up their hands and said, “Why bother?” Well, you should bother.
Financial advisers point out that anything saved is better than nothing. But for those without a company pension plan, a more-than-subsistence retirement (retirement benefits from the Canada Pension Plan and the Old Age Security program) will require some kind of saving. RRSPs are not the only way of saving for retirement, of course. But for most Canadians, they’re the best way.
The reason most people go to work, is to get cash flow. This cash then goes to pay bills etc. When you retire - you don’t have this ready source of cash flow each and every month from your work. Instead you have to rely on what ever other sources you have to get your monthly/weekly cash flow. Because get what, your bills etc don’t disappear once you retire. This is why you do an RRSP, to help with obtaining a ready source of assets to provide a cash flow.
Think of an RRSP as a glass. In a glass, you can put different things: Fluids like water and milk and I put loose change in mine! The glass is the RRSP. What you put in it are the investments.
The unique benefit of an RRSP plan is that when you put money into it, it reduces your taxable income in the current year. And then as you make money in the plan, you’re not subject to tax. You do get taxed on withdrawal, but not until then.
Smart financial advisors always advise people to automatically pay yourself first. In other words, it’s easier to put $200 a month into an RRSP than to come up with $2,400 once a year. Monthly saving also allows you to dollar-cost-average your purchases - the same $200 will buy more units of a mutual fund when unit prices are low, and fewer units when prices are high.
Oh yea, and as to how much should I have in an RRSP, it’s really an understanding of cash flow.
This is just a rough piece of math’s, for better understanding I would strongly recommending sitting down with your advisors.
- Determine at what age you want to retire
- Figure out how much you require to live on each month - subtract any OAS and CPP you will receive from this number
- multiply that number by 12, for the yearly sum you require from investments
- then multiply that number by 16
This is the amount you will need to have at retirement to provide you with an income per month for your needs.
Again, see a financial advisor for the exact maths.
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Q - What’s the deadline?
A – Well, that’s a bit of a trick question. It’s seems like that as Canadians we always need a deadline to motivate us to do anything, RRSPs, taxes, Sales at Canadian Tire, and changing our brakes. Well, when it comes to RRSPS in reality there is none. You can make a contribution at any time. The only RRSP deadline you face is if you want the tax break applied to your 2007 income. In that case, the deadline is midnight, Friday, Feb. 29, 2008. But you can always carry forward unused RRSP contribution room to next year, or the year after that, and so on.
The thing about an annual carry-forward, of course, is that they can quickly mushroom into a mountain of room that will stay unused unless you win a lottery or get an inheritance. If you can’t muster $2,000 this year, will you be able to find $4,000 next year, or $6,000 the year after that?
Again to get aroudn this deadline, make a habit of putting some money aside monthly for that time when you will not have any money to put aside.
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Q - How much can I contribute?
A - For the 2007 tax year, people can contribute up to 18% of their earned income from the previous year, up to a maximum of $19,000.
But the contribution calculation isn’t that simple. From that figure, you must subtract your pension adjustment (PA). If you’re a member of a pension plan at work, you’ll have a pension adjustment. This amount takes into account the money you and/or your company contributed to an employer-sponsored pension plan. Your T4 slip records the pension adjustment figure.
To this figure, you must then add the total carry-forward of unused RRSP contribution room since 1991. For some taxpayers who haven’t been stuffing their RRSPs, this can amount to more than $100,000.
There’s an easy way to find this figure without doing all the calculations. Just check the Notice of Assessment you got from the Canada Revenue Agency last year, or phone the tax department’s T.I.P.S. line at 1-800-267-6999. You will be asked to provide your social insurance number, your month and year of birth, and the total income you reported on line 150 of your 2006 return.
While there seems to be enormous pressure for everyone to contribute to RRSPs, there may well be a better way to use your money. For those with a lot of high-interest credit-card debt, it may be better to pay that off first.
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Q - Are RRSPs only for retirement?
While RRSP stands for Registered Retirement Savings Plan, the government has brought in two provisions that allow Canadians to access RRSP money for reasons other than their golden years.
The Home Buyers Plan (HBP) has been enormously popular in Canada, with almost 1.4 million people taking advantage of it as of 2004. Since 1992, more than $14 billion has been withdrawn. As long as the money is used to buy a qualifying home, no tax is paid on the withdrawal. The catch is that the money must be repaid to your RRSP over the next 15 years or the minimum annual payment will be added to your income and you will pay tax on that. And the repayment is not tax-deductible (you got the tax break the first time you put in the money). The full rules are complex, so check with the Canada Revenue Agency and your financial adviser.
The Lifelong Learning Plan (LLP) allows Canadians to pull up to $20,000 from their RRSPs to head back to school. The withdrawals can be a maximum of $10,000 in any one year and can be spread over four years. Repayment is on a 10-year schedule. Again, familiarize yourself with the rules and limitations and seek financial advice before doing anything. About 49,000 people have withdrawn $363 million since the LLP began in 1999.
Another thing, you can take the money out whenever you want, especially when you have a low taxation year. You just have to be aware of the tax consequences. Again a Financial Advisor is critical here.
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Q Is there a downside to contributing to RRSP’s?
A - There may be - in very limited circumstances.
If you are a low-income Canadian and you believe that your RRSP will NOT exceed, say, $30,000 (more or less) in your retirement years, then having an RRSP may mean that you will not enjoy all the government programs designed for low-income Canadians.
However, if you are planning to save for your retirement, the RRSP is the most tax-efficient vehicle there is given the alternatives out there.
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Q - If possible should we always contribute the maximum RRSP allowable?
A - The answer to this may very well be “no,” and here’s the reason why.
Believe it or not, some Canadians “over-save!” Most financial planners expect that, in retirement, our income needs are about two-thirds of what they were when we were actually setting the alarm, getting up in the morning, etc., etc., etc.
Therefore, based on reasonable assumptions about 1) what age you plan to retire at and 2) an estimate about life expectancy, I would strongly recommend that you sit down with a financial planner and work out how much money you require to have a comfortable retirement. And in this calculation, don’t forget about Canada Pension Plan benefits and Old Age Security! I find that an independent financial planner - not linked to a bank, or a financial institution, such as an insurance company are the best. Independence does have its merits.
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Q - How much should I contribute to my RRSP to avoid paying additional taxes this year? Is there a formula I can use?
A - This is particular to each individual.
If you know how much you are going to make this year (which you should) you can “work backwards.” Let’s say that your income is $50,000. The combined marginal tax rate in the Province of Ontario works out to about 35%. Therefore, if you put in $5,000, it would reduce your tax burden by about $1,750.
But I’d stress that this calculation is unique for EACH investor depending on a variety of factors, including income, exemptions and the nature of the income. What I can tell you for sure is that each dollar of RSP contributions DOES reduce your current tax burden - but make sure you respect the maximum limits imposed by the government!
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Q - Will the current market volatility benefit or negatively impact the average RRSP in the long term? I keep hearing investment advisors say that there are great deals to be had right now and I assume that RRSP managers are taking advantage of these “deals”, is this assumption correct.
A - If you are contributing regularly to an RRSP and have a long-term time horizon, ironically enough dips are good. Here’s the logic why.
Let’s say that right now an investment unit is $10. A $100 contribution buys 10 of them and I expect that if the market performs as expected, the units will be worth $26.50 in about 20 years. (I assumed a 5% growth, which is much less than the markets.) So my $100 contribution grows to $265. Now there’s a downdraft and instead of my $100 contribution buying 10 units at $10, it buys 11 units at $9. Now if they’re worth $26.50 per unit, I’ve got $291.50 instead of $265. It’s counter-intuitive - but the numbers bear it out. assuming that you are disciplined enough to buy the dips!
The current volatility only makes a difference to you if your retirement is in the next 10 years. If it is over that time period that it has no serious impact and can be taken advantage of.
If you are retiring within ten years, then perhaps you should be re-assessing your tolerance to volatility.
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Q - I’m currently on 2nd year of owning my first house with my wife. I have used almost all of my RRSPs to avail of the government’s HBP on purchasing the house. How do I repay the RRSPs that I’ve withdrawn? Do I have to buy RRSPs from the same financial institution I’ve bought my RRSPs originally?
A - Under the terms of the HBP, you are REQUIRED to “pay yourself back” in regular installments. You are free to put it into an RRSP anywhere, not just the one you took it out of
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Q - If I was a farmer why would I invest in RRSP’s when I can make more money investing in livestock (cows, sheep, etc…) How do you convince this farmer to invest in RRSP’s?
A - To anyone who is thinking that they can make more money outside an RRSP I would say the following: Will you make more on an after-tax basis? Because the growth in an RRSP occurs tax free? Will your return on livestock reduce your current tax burden, because RRSP contributions will do that? Are you diversified - that is - have you spread out your eggs among a number of baskets?
By the way, if you are sure that you can make more, lots and lots more, in livestock, then it could be the correct decision. Just accept that there may also be higher risk going down this road.
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Q - For those who put off contributing to RRSPs earlier in life, what advice could offer to get these people (and I fall under this category) on track for?
A - I’d just say that you shouldn’t lose sight of the benefits of RRSP investing: reducing taxes now and tax-sheltering the growth of income. You can’t turn back the clock, but it doesn’t mean that if you currently regret the decision, you’ll regret it any less by delaying further.
Procrastination is one of Canadians worst vices - along with believing politicians are telling the truth!
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Q - We have always maxed out our RSP contributions and are now afraid to contribute this year due to market viability. Is there any way to make contributions to that will not be as risky?
A - I understand your concern - but here’s something you may not realize. You can put money into an RRSP and NOT purchase mutual fund units, instead letting it sit in cash until things calm down a bit. You don’t have to invest your money in the stock market right away and in fact you don’t have to invest in the stock market at all if you don’t want to. If you have a Financial Planner, ask him to explain the investment options out there, because there are many when it comes to products allowable in an RRSP plan.
If you are concerned about the markets, then take the time to visit with your advisor. Another worst mistake you do, - is not talking to them.
Sometimes, it good to look at history and see similar conditions as today, and determine what was the outcome then. After that, ask yourself is today’s situation worse than it was then. As an example, in 1991 we had the S&L crisis that rocked the financial markets - it was over in a short time, and the markets went well after that. The smart investors were the one’s that took advantage and invested with an understanding of what they held.
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Q - I am already contributing to a pension fund as a government employee, is it still advisable to contribute to an RRSP in addition to this?
A - This is a tough call. It really depends on how much money you expect to have from your pension at retirement, and how you envision your lifestyle in retirement.
Here’s what I would do if I were you. Call your Pension Administrator and ask them what they estimate you’ll receive at retirement. Let’s say that they said in 20 years you can expect $50,000 per year. Remember to adjust that amount for inflation which should average about 3% or so over the next 20 years, which means your $50,000 will actually have about $28,000 of buying power. Then you can intelligently determine whether you would like to save more for the future, or enjoy the present more!
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Q - Is their a minimum age for contributing to RRSP’s? When is the best time to start thinking long term?
A - There is not a minimum age.
However for most Canadians, it is most appropriate to think about retirement after entering the workforce full-time. If you start early with a disciplined plan, you can enjoy the present and have lots of money saved for the future. I would encourage you to consult with your financial advisor (there’s usually no fee for a Consultation) and then you can explore your options further.
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Q - Do you think that Mutual Funds, with their management expenses running as high as 2.5 to 3% in some cases, represent a better investment in a flat or bear market, where professionals can really show their skills, than they do in a bull market where the rising tide tends to life all boats?
I think the mis-information about mutual funds is huge out there. Because of their sheer numbers there will be a majority that under perform some index. But that doesn’t; take into account those that do,
Also, it’s necessary to understand the positive and negative returns of an investment. Most funds will not under perform an index when the index goes down 60% like it did after the tech crash.
The objective is to find an investment that is within your risk tolerance and can meet your objectives. And yes, professional management does do better - just ask David Dreman, just as Tom Marsico, Charles Brandes, Gerald Cooper Key, Bob Tattersall, George Frazer, etc - all good managers that have demonstrated to manage with a risk tolerance and obtain a long term result that fulfills planning objectives.
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Q - I make a lump sum contribution to my RRSP in February each year. Due to the present market volatility, is it better to use money to make monthly contributions? If yes, over what length of time? I do realize that I will not be able to claim the tax savings this year but I can reduce tax paid at source for these monthly payments.
A - UNDER ALL CIRCUMSTANCES, I strongly recommend monthly contributions which are directed to purchase investment units at regular intervals. Timing the market is a very dangerous game!
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Q - What is the best strategy for using up your previous year’s (over 10 years) unused contributions? How do you find out how much is available?
You will learn how much is available by looking at the Tax Assessment from the Government. It’s clearly there in the summary. The “best” strategy would be to contribute to lower yourself to another, lower marginal tax bracket. If you’re making something just over $74,358, get under that benchmark. If you’re making something just over $37,179 get below there. I would not recommend taking out loans to accomplish this because the interest payments are NOT tax-deductible. Just do it gradually over time.
I am usually not a fan of non-deductible loans.
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Q – What are some of the major mistakes people make with their RRSPs
A – Here are some of the biggies I have seen, there’s probably a whole lot more
1. Often people rush to make a last-minute RRSP contribution and give little thought to the underlying investment.
Spend a few minutes to remember how long it took you to earn that money and slow the selection process down.
Solution: If you are in a rush we recommend you consider making contributions to your RRSP in cash and look at all your available investment options prior to making an investment decision.
2. Over-contributing to your RRSP may result in T1-OVP penalties and interest. This past year we noted a campaign by Canada Revenue Agency that resulted in several letters being sent to individuals who have made over-contributions. Solution: Before you contribute, be certain of your limit.
3 . People with an RRSP account should understand that all income generated in the account is tax deferred. This is by far the biggest advantage of an RRSP. Over time, this should save you much more in taxes than the initial deduction for the contribution. People who have non-registered investments understand that income generated in these accounts is taxable. Pulling funds out of an RRSP prior to age 72 is generally the wrong decision when non-registered funds are available. There are some exceptions, such as shortened life expectancy. Solution: Using the capital within your non-registered investments first will reduce your current annual income and defer taxes further.
4. Some people have multiple RRSP accounts held at different financial institutions. They may have $10,000 at Institution A from a 2004 RRSP contribution, $6,000 at RRSP Institution B from a 2005 RRSP contribution, and $8,000 at Institution C from a 2006 RRSP contribution. This may result in additional RRSP fees being charged to you and result in more fees than you need to pay. More importantly, your investments become more difficult to manage. Solution: Consolidate your RRSP accounts at one advisor for better management, to reduce fees and to open up more investment options. Make sure he is independent.
5. When you open an RRSP account you must make a beneficiary selection. If you are married or living common law then the natural choice is your spouse for the tax-free rollover provisions on the first passing. Often, widows will still have their deceased spouses named as beneficiary. We have seen cases where people have remarried and have their ex-spouse still listed as a beneficiary. In some cases naming your estate may be the best option. Solution: Speak with your adviser and ensure you have the correct beneficiary on your RRSP account.
6. People who do not have pension income (not including CPP and OAS) should ensure that they are taking all planning components into consideration before requesting early RRSP withdrawals. Withdrawals from an RRSP are not eligible for the pension income amount and they are not eligible for income splitting. Solution: If you require funds, we encourage you to wait until at least age 65 and then convert funds to a RRIF before withdrawal. RRIF income received at age 65 or older may be eligible to be split and qualify for the pension income tax credit ($2,000 each per year).
7. One of the biggest mistakes we see is failure to make an RRSP contribution. Individuals who are making large salaries without a pension need to take advantage of their RRSP contribution room. Not having the discipline to set aside funds for retirement will result in making sacrifices at retirement. Solution: Consider making an RRSP contribution.
Rational - If you don’t believe that the education system in this country has gone to hell, just take a look at all the people who can’t even count to ten in front of you in the express lane at the supermarket.