RRSP Season: What You Need to Know

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There’s more to RRSP season that is presented

Eric Tippelt | February 23, 2017 | SmallCapPower: February is the start of so-called Registered Retirement Savings Plan (RRSP) season. Every type of investment house is running ads about contributing to your RRSP. But like most things financial, there is more to the story than is presented.

RRSPs have been around since 1957. The RRSP was introduced as a way to encourage Canadians to save for retirement. The incentive was that the government would allow you to deduct your contribution from your income, thereby giving you a potential refund at tax time. It was, and is, a great selling feature.

Your RRSP is more than a Savings Plan. It is a file folder to hold many different types of investments, with rules about how investment income and withdrawals are treated. You can have multiple RRSPs in different places. The amount you can contribute is based on a percentage of your income (18%). If you don’t contribute the full amount each year, you can build up extra room.

Many companies that don’t offer a Pension plan (and many that do) will contribute to your RRSP at some percentage of how much you contribute. This is definitely something to take advantage of. If your company gives you $1.00 for each $1.00 you contribute, this is a 100% return on your investment. Great.

You need to remember that the RRSP is a TAX DEFERRED plan. You might get a tax break now, but you will eventually have to pay the taxes on ALL of the RRSP amount.

Here is how it works when you make a contribution.

The main attraction of the RRSP is Tax Reduction and, most importantly, your investments held in the RRSP grow tax free – for now.

However, if you need to take money out of your RRSP, before retirement, there are a lot of issues. For example, if you are unemployed for awhile and need money from your RRSP, it is not easy to get, and has two drawbacks.

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First, depending on the amount you take out, there is a withholding tax of 10% or more. So, if you take out $10,000.00 you will only get $7000.00. Second, you will have to declare the $10,000 as income. Since Employment Insurance (EI) is based on your income, there is a possibility that you might have to pay back some of the EI you’ve received.

You can use RRSP money for a down payment on a first home. But, you have to pay it back in 15 years. Also, each year you have to pay back at least 1/15th of the amount or, you have to claim that amount as income that year. Forget using it as a down payment on an income property, it’s not worth it.

The types of investments you hold in your RRSP should be age dependent. Younger investors can have more aggressive investments as they have time to make up for any possible losses. Older investors may want more security.

The biggest surprise for many people comes at retirement. I found out about this when my dad and a bunch of his friends started making withdrawals. They were all complaining that they had been told that their tax rate in retirement SHOULD be less than while working. Yet, they were paying the highest taxes of their lives on the RRSP withdrawals.

Most people don’t realize that different types of income are taxed at different rates. That is because, for many people, earned income is all they have had to deal with so far. Earned income is taxed at one rate, interest income is taxed at another, capital gains are taxed at another, etc. As it turns out, interest income is one of the highest rates. Most safe RRSP investments are based on interest income.

Since you are on this site anyways, it might be worth mentioning that you can have a Self Directed RRSP as your online Trading Account. You can buy many Mutual Funds, or ETFs without having to go through the different company’s representatives and hold them in an RRSP. This will also allow you to hold stocks and bonds easily.

RRSPs are a good way to save for your retirement, but talk to a tax accountant about how to maximize your contributions and investments. This is critical no matter what stage of life you are at.

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Eric Tippelt is a full time professor of electrical automation at Loyalist College in Belleville.  He has been studying money and finance since 2004 when he began his online trading activities.  Eric writes about Micro Investing ($500.00 to $1,000), because there is very little information out there on how to invest at that level.  

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