The Beginner’s Guide To RRSPs

More than sixty years after the federal government introduced the Registered Retirement Savings Plan as a vehicle to save for the future, RRSPs still remain one of the cornerstones of retirement planning for Canadians. In fact, as employer pension plans become increasingly rare, the ability to save inside an RRSP over the course of a career can often make or break your retirement.

Here’s a beginner’s guide to RRSPs:

The deadline to make RRSP contributions for the 2018 tax year is March 1st, 2019.

Anyone living in Canada who has earned income can and should file a tax return to start building RRSP contribution room. Canadian taxpayers can contribute to their RRSP until December 31st of the year he or she turns 71.

Contribution room is based on 18 percent of your earned income from the previous year, up to a maximum contribution limit of $26,230 for the 2018 tax year. Don’t worry if you’re not able to use up your entire RRSP contribution room in a given year – unused contribution room can be carried-forward indefinitely.

Keep an eye on over-contributions, however, as the taxman levies a stiff 1 percent penalty per month for contributions that exceed your deduction limit. The good news is that the government built in a safeguard against possible errors and so you can over-contribute a cumulative lifetime total of $2,000 to your RRSP without incurring a penalty tax.

Find out your RRSP deduction limit on your latest notice of assessment or online using CRA’s My Account service.

You can claim a tax deduction for the amount you contribute to your RRSP each year, which reduces your taxable income. However, just because you made an RRSP contribution doesn’t mean you have to claim the deduction in that tax year. It might make sense to wait until you are in a higher tax bracket to claim the deduction.

When should you contribute to an RRSP?

When your employer offers a matching program: Some companies offer to match their employees’ RRSP contributions, often adding between 25 cents and $1.50 for every dollar put into the plan. Sadly, many Canadians fail to take advantage of this “free” gift from their employers – giving up a guaranteed 25-to-150 percent return on their contributions.

When your income is higher now than it’s expected to be in retirement: RRSPs are meant to work as a tax-deferral strategy, meaning you get a tax-deduction on your contributions today and your investments grow tax-free until it’s time to withdraw the funds in retirement, a time when you’ll hopefully be taxed at a lower rate. So contributing to your RRSP makes more sense during your high-income working years rather than when you’re just starting out in an entry-level position.

RelatedA sensible RRSP vs. TFSA comparison

A good rule of thumb: Consider what is going to benefit you the most from a tax perspective.

When you want to take advantage of the Home Buyers’ Plan: First-time homebuyers can withdraw up to $25,000 from their RRSP tax free to put towards a down payment on a home. Would-be buyers can also team up with their spouse or partner to each withdraw $25,000 when they purchase a home together. The withdrawals must be paid back over a period of 15 years – if not, the amount is added to your taxable income for the year.

Beware of raiding your RRSP early

Unless it’s a dire emergency then it’s generally a bad idea to withdraw from your RRSP before you retire. For starters, you have to report the amount you take out as income on your tax return. Not to mention you won’t get back the contribution room that you originally used.

To make matters worse, your bank will hold back taxes – 10 percent on withdrawals under $5,000, 20 percent on withdrawals between $5,000 and $15,000, and 30 percent on withdrawals greater than $15,000 – and pay it directly to the government on your behalf. That means if you take out $20,000 from your RRSP, you’ll not only end up with just $14,000 but you’ll have to add $20,000 to your income at tax time.

What kind of investments can you hold inside your RRSP?

A common misconception is that you “buy RRSPs” when in fact RRSPs are simply a type of account with some tax-saving attributes. It acts as a container in which to hold all types of instruments, such as a savings account, GICs, stocks, bonds, REITs, and gold, to name a few. You can even hold your mortgage inside your RRSP.

If you hold investments such as cash, bonds, and GICs then it makes sense to keep them sheltered inside an RRSP because interest income is taxed at a higher rate than capital gains and dividends.

A good approach, depending on your age and stage, is the tried-and-true balanced portfolio consisting of 60 percent stocks and 40 percent bonds. You can achieve this mix with one balanced mutual fund, one balanced ETF, or a couple of low cost index funds or exchange-traded funds (ETFs).

Weekend Reading: RIP John Bogle Edition

Vanguard founder and index investing pioneer John Bogle passed away this week at the age of 89. Bogle was a legend in the investing community for driving down costs for individual investors.

His flagship index mutual fund, now known as the Vanguard 500 Index Fund, amassed just $11 million when it was introduced in 1976. Today, it’s one of the largest funds in the industry with more than $400 billion in assets.

John Bogle

Bogle’s selfless desire to reform the investment industry and eliminate sales charges has undoubtedly saved investors hundreds of millions of dollars in commissions. He also authored The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns (now in its 10th edition).

If a statue is ever erected to honor the person who has done the most for American investors, the hands-down choice should be Jack Bogle. For decades, Jack has urged investors to invest in ultra-low-cost index funds. In his crusade… Jack was frequently mocked by the investment management industry. Today, however, he has the satisfaction of knowing that he helped millions of investors realize far better returns on their savings than they otherwise would have earned. He is a hero to them and to me. – Warren Buffett

Tributes to John Bogle poured in from around the investing community. Here are some of my favourites:

Rest in peace, John.

This Week’s Recap:

On Monday I shared a story of an elaborate gift giving ceremony known as a potlatch.

On Thursday I urged readers to look at their monthly subscriptions and cancel the ones that aren’t used or no longer offer value.

Happy Go Money giveaway

Last weekend I reviewed Melissa Leong’s excellent new book, Happy Go Money. To enter the book giveaway I asked readers to share their most recent money accomplishments. The responses were amazing – 103 comments in total.

From that list I used a random number generator to select two winners who will each receive a copy of Happy Go Money.

The winners are:

  • Brad S., who commented on January 12, 2019 at 8:14 am
  • Gary, who commented on January 12, 2019 at 7:00 am

Congratulations, and thanks to everyone who entered!

Promo of the Week

Earlier this year I highlighted RBC’s NOMI Find & Save program – the first in Canada to proactively analyze your spending and saving, to find those extra dollars that you won’t miss, and set them aside for you automatically — to a maximum of $50/day, up to five times per week.

“With a tool like NOMI, you’ve got a digital buddy that will automatically shuffle $25 into your savings account when you underspend your grocery budget for the month.”

NOMI Find & Save launched in Fall 2017 and in its first year, helped clients find and save over $35 million. Clients who are actively using NOMI Find & Save are saving an average of $140 a month.

This feature is now available to joint account holders, making it easier for you and your partner to manage your finances and fast track your savings goals as a household unit.

Weekend Reading:

Here’s how active baby boomers are rewriting the retirement myth.

From The Harvard Business Review: How retirement changes your identity.

The real reason people fail to save enough for retirement — and what you can do to limit the damage.

Spending on experiences may be better than on things in many cases. But not spending money you don’t have trumps all strategies:

Rob Carrick and Shannon Lee Simmons say credit cards get the hate, but HELOC’s are the crushing debt.

Why is that? The problem with home equity lines of credit is perma-debt.

Barry Ritholtz says stock pickers do an okay job figuring out what to buy, but they need to do a better job unloading stuff.

Ben Carlson argues that complex systems combined with the human element are two skills that normally don’t go together.

The Blunt Bean Counter Mark Goodfield shares a simple tool to help you organize your estate.

When kids squander money, parents are squarely to blame.

Here’s what fees can do to your retirement if you don’t pay attention:

When it comes to investing, here’s why diversification is (almost) undefeated.

Finally, Chris Taylor argues that a side benefit of a Dry January is saving money. Indeed.

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