The basics The facts you need to know to survive this RRSP season
It's RRSP time again and we have until March 1 to make our contributions to qualify for a tax deduction on our 2006 income tax return.
A recent study by RBC Financial Group suggests that Canadians regard saving for retirement as their No. 1 priority - no surprise given our aging population. In practice, however, our savings rates are deplorable; a recent Statistics Canada report, for example, found that nearly 30 per cent of Canadian families have no personal retirement savings.
As an investment professional working through 16 RRSP seasons, I've drawn up a list of the most common questions about saving for retirement:!
What is an RRSP?!
A registered retirement savings plan is, as its name suggests, a plan registered with the Canada Customs and Revenue Agency that lets you save money on a tax-sheltered basis. You can set up an RRSP at any financial institution, either on your own or with the help of an adviser.!
Who can have one?!
Anyone who has a social insurance number, has earned income and has filed a tax return can contribute to an RRSP until Dec. 31 of the year he or she turns 69. If you continue to earn income after this age, you can contribute to a spousal RRSP until Dec. 31 of the year your spouse turns 69.
Why is it a good idea?!
RRSPs are one of the best ways to realize an immediate tax savings - and who doesn't like to save on taxes? The amount saved depends on your income and personal tax rate; for example, if you live in Ontario and earn $50,000 a year, every dollar invested in an RRSP will save you 31 cents. Where else can you find a guaranteed 31-per-cent return on your dollar?
How should I invest?!
There is a wide range of RRSP products and strategies to choose from - savings accounts, guaranteed investment certificates, bonds, mortgages, mutual funds, stocks, even cash. The range of choices reflects the wide variety of investors, and varying needs and goals. Proper investing for retirement should take into account your financial situation, the time available to you, your tolerance for risk, your investment objectives and your financial savvy.!
How much can I contribute?!
Maximum RRSP contribution limits have been increasing over the past few years. For 2006, you can put away 18 per cent of your previous year's income, to a maximum of $18,000. And if you have not used all of your RRSP contribution room in the past, the amount can be carried forward and accumulate. If you contribute to a pension plan at work, you must account for those contributions through something called a pension adjustment.
Although contribution calculations can be rigorous, the good news is that the government keeps track of it for you. The easiest way to know how much you can contribute for 2006 is to look at the "Notice of Assessment" portion of your income tax return from last year. !
What if I put too much into my RRSP?!
Everyone has a lifetime "over-contribution" limit of $2,000, which essentially means you can contribute beyond your limit by that amount without paying tax. If you exceed the $2,000, however, you face a penalty of 1 per cent per month on any amount over your limit.!
When should I withdraw RRSP money?!
Any money withdrawn from an RRSP is fully taxable as income. If you must withdraw money before retirement, do it when you are in a lower tax bracket.
Far too often, I see people dipping into their RRSP money while they are still working, which isn't a good idea because you're taxed on those withdrawals you're saving for retirement, use an RRSP and make the most of the tax breaks - both while you're earning and when you're not.!
Is it better to invest in RRSPs monthly?!
There's an old saying that most people spend first and then save whatever is left over. The better approach is to save first and spend second. The best way to do this is to make regular RRSP contributions: the sooner your money goes in, the longer it will work for you tax-free. Many employers can deduct regular contributions from your paycheque, and any financial institution can arrange to have money deducted from your bank account at whatever intervals you prefer.
If you're in the habit of making last-minute RRSP contributions, it's time to break free. Start a monthly plan for your 2007 contributions, and spare yourself the stress of meeting the last-minute deadline next year. The sooner your money goes in, the longer it can grow tax-free. !
Is it better to buy RRSPs or pay down my mortgage?!
This is a perennial debate for many Canadians. In most cases, the tax savings provided by an RRSP more than outweighs the interest saved by paying down your mortgage, especially when mortgage interest rates are low. For example, if you have $5,000 to invest in an RRSP and you get a $1,500 tax refund as a result, you can then apply that $1,500 to your mortgage. Not only have you saved on your tax bill, the government is essentially paying down your mortgage. You've just turned $5,000 into $6,500.!
Can I buy real estate with my RRSPs?!
Given the booming real estate market in many parts of Canada, this is a common question. Although you cannot use your RRSPs to invest directly in a property there are ways to invest in real estate using your RRSP money. In 1992, the government introduced the Home Buyers Plan, under which you can withdraw up to $20,000 toward the purchase of your first home (though you must repay the amount later, or incur taxes). As well, there are currently 12 mutual funds that invest directly in real estate. Remember that if you own your home, real estate is already one of your biggest investments, so take that into consideration before you invest in too much real estate and forget to diversify your holdings.!
James Yih is an Edmonton-based financial adviser and author of Mutual Fundamentals and Seven Strategies to Guarantee Your Investments.