In this series of ‘Investment Basics’, we will go over some of the vehicles Canadians can use to accumulate wealth.
Essentially, in Canada, we (generally) have 5 investment vehicles the general public can use to accumulate our assets/wealth: RRSPs, TFSAs (Tax-Free Savings Account), Open (Non-Registered) Plans, Real Estate and CVI (Cash Value Insurance) – [a 6th would be using a corporation, for business owners]. Each one of them has their pros and cons and each must be used according to each client’s individual situation and goals.
In this Part 1 of the series, we will go over the RRSP, as it is one of the more commonly used and well known in the industry.
What is an RRSP?
An RRSP is an investment vehicle that allows Canadians to grow money tax-deferred (this means you don’t pay taxes on the money until it is withdrawn). When a person makes a contribution to their plan, they get a tax deduction for the amount that was contributed. This can be a great thing for those who are in higher tax brackets, and can also help them get into a lower tax bracket.
Any income within the RRSP is not taxable while it is still within the plan and grows tax-deferred until it is withdrawn. The funds can be withdrawn at any time, but not without any consequence. The withdrawn amount gets added to the persons earned income and can potentially put them into a higher tax bracket. There are also taxes that are withheld at time of withdrawal, which is based on the amount withdrawn.
A person can keep funds within an RRSP until the end of the year in which they turn 71, at which point it must be converted into a RRIF (Registered Retirement Income Fund).
Why RRSP?
An RRSP can be a great way to invest for your future, if it is done properly. Let’s take a look at a few benefits of the RRSP:
– Tax Deduction
– Tax Deferred Growth
– Possibility of putting you in a lower tax bracket
– You can use funds within an RRSP for First Time Home Buyers plan [HBP] (funds must be repayed within 15 years of withdrawal otherwise they are subject to taxation)
– You can set up a Spousal RRSP to split income and lower the overall household taxes paid
– Unused contribution gets carried forward
– You can use funds within an RRSP for Lifelong Learning Plan [LLP] (funds must be repayed within 10 years of withdrawal otherwise they are subject to taxation)
– In the event of death, the RRSP can be rolled over (i.e. transferred over) to a spouse’s or a common-law partner’s RRSP tax-free
As you can see, the RRSP can offer several benefits to those, IF it is used properly.
Is it right for me?
Although an RRSP can be a great vehicle to use for many Canadians, it is not always a great fit for everybody. It’s always best to sit down with an Elite level Financial Advisor to go over all the details to see if this strategy would be a good fit in your portfolio. Some things to consider are:
– Current Income
– Current Tax Bracket
– Future Income Potential
– Type of Income (Salary or Self-Employed?)
– Estimated Income at Retirement
– Overall Net (Tax) Benefit vs other Vehicles
Things to be aware of
Even though there are many benefits to an RRSP, there are also many things to be aware of, that most people are not aware of because they are not told. Some of these things include:
– There is contribution limit (based on previous years income as stated on taxes)
– All growth within the RRSP is considered as “interest income” no matter which type of growth it was (capital gains, dividends, or interest). This means when you withdrawal, you will be taxed at your tax bracket and there are no tax benefits for different types of investments
– You will be taxed on the FULL amount of withdrawal, and not just the growth, within the RRSP
– Once you reach age 71, you MUST either a) transfer the funds into a RRIF (which results in forced withdrawal from the RRSP) b) purchase an annuity or c) withdrawal the amount in full
– You can end up paying more money in taxes in your later years if your income is higher; this could negate any tax deductions you had received in previous years; you can possibly pay more money in taxes in retirement then you saved in the earlier years
– There is a limit that you are able to contribute every year; A Tax of 1% per month applies on the portion of your RRSP contribution that exceeds your RRSP deduction limit and the over-contribution limit of $2000
– Interest on funds borrowed to invest into an RRSP is not tax-deductible (as they would if they were invested into an Open [non-RRSP] Investment)
– If funds are not re-paid within the specified timelines for the Home Buyers Plan and the Lifelong Learning Plan, you will be subject to taxation
Contribution Limit
The maximum RRSP contribution limit for 2015 is $24,930. However, if you did not maximize your RRSP contribution limit for previous years, you can carry that unused amount forward. Therefore, your RRSP contribution limit may actually be more than the 2015 contribution limit.
Now, it is evident that there are many things that you should be aware of before using RRSPs as your investment vehicle. As mentioned before, they can be a great investment vehicle IF used properly. One of the main issues with RRSPs is not the actual vehicle itself, but rather how they are marketed; they’re marketed as the “one size fits all, for everybody, in every situation”, which is definitely not the case. The traditional industry has not done a great job on educating clients on how RRSPs work and, generally, have not set them up properly. Many ‘Advisors’ are more concerned about ‘getting another account’ that they are not properly educating clients on whether that vehicle is actually right for them.
Having an Elite level Financial Advisor can help educate and show you if using an RRSP (or any other vehicle) would benefit you, and how. Every piece of a client’s Financial puzzle should fit in and compliment the other pieces. An integral part of Investment Planning is also looking at the back end Tax consequences, and only an Elite level Financial Advisor would be able to effectively go through the numbers with you.
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