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 2022 tax year is March 1, 2023.
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% of your earned income from the previous year, up to a maximum contribution limit of $29,210 for the 2022 tax year, and $30,780 for the 2023 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% 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% 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.
Related: A 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 $35,000 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 $35,000 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.
*Note, watch for the new First Home Savings Account coming later this year, an account that allows you to contribute up to $8,000 per year to a lifetime limit of $40,000. Contributions are tax deductible, and withdrawals are tax free if used to purchase a qualified home.
When you want to increase your Canada Child Benefit payments: An RRSP contribution reduces your net income, a measure which is used to determine how much parents will receive from the Canada Child Benefit program. These tax-free benefits are reduced or phased-out at certain income thresholds. Young families should consider making an RRSP contribution to lower their adjusted net family income and get more from the Canada Child Benefit program.
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 financial institution will hold back taxes – 10% on withdrawals under $5,000, 20% on withdrawals between $5,000 and $15,000, and 30% 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.
Related: 5 common myths about RRSPs
If you hold investments such as cash, bonds, and GICs then it can make 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% stocks and 40% 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).
Final Thoughts
Contributing to an RRSP is simply one of the best ways for Canadians to save for retirement and reduce their tax burden. The RRSP advantage is further heightened when you consider employer-matching programs, access to the Home Buyers’ Plan, and potentially increasing your Canada Child Benefit payments.
The idea is to contribute to your RRSP in your higher income earning years and withdraw from it in retirement, when income is typically lower. Your contributions, invested sensibly, will grow in a tax-deferred manner until retirement, when withdrawals are fully taxable.
Last year was brutal for both stocks and bonds. In the middle of the year, during what turned out to be the market bottom (and inflation peak) I suggested you stop checking your portfolio. This comes from the analogy that your portfolio is like a bar of soap; the more you touch it the smaller it gets.
The idea that stock and bond prices can fall in the short-term is precisely why investors are rewarded in the long-term. The problem is it’s hard to stick with even the most sensible investment plan because markets are extremely noisy and we almost always feel compelled to act.
I hear this from readers and clients all the time. In the 2010s it was all about the S&P 500. No reason to diversify beyond the top 500 U.S. companies when it’s the best performing index (completely ignoring the previous “lost decade”).
From 2020 to 2021 it was all about the NASDAQ. High-flying tech companies were changing the world and you were missing out if you didn’t add a technology “kicker” to your portfolio.
Investors who didn’t diversify beyond U.S. equities or large-cap technology stocks got a rude awakening last year. The NASDAQ was down 33%. The S&P 500 was down 18%. Meanwhile Canadians stocks were down 8.5% and a global portfolio of stocks was down about 11%.
Now what I’m hearing from readers and clients is that after a year of losses, investors are ready to capitulate and move to GICs. They’re forgetting:
“Investors who focus too much on short-term performance tend to react too negatively to recent losses, at the expense of long-term benefits.”
I don’t have a crystal ball to tell you how to position your portfolio in 2023. Last year I said to lower your expectations for future returns after years of outsized performance. Now the best I can offer is that we can increase our expectations for future returns after both stocks and bonds suffered double-digit losses.
So what should you do? Start by ignoring these three investing headlines this year.
1.) 2023 stock market predictions
Nobody else has a crystal ball either. So why do we eat up these market predictions every year? Besides being nothing more than useless guesses, most predictions invariably go with the current trend.
Last year’s predictions were for the stock market boom to continue (oops!). This year’s predictions are much more pessimistic.
This graphic from the Honest Math website has it right:
2.) Last year’s top performing stock(s) and ETF(s)
Back in the day (I’m talking in the original Wealthy Barber days), investors and their advisors picked investments after combing through performance reports to find last year’s top mutual fund managers and best performing stocks.
But decades of research and data now show this to be a laughably ineffective way to pick investments. Yes, there are a handful of active managers who outperform their benchmark index. The challenge is that it’s impossible to identify them in advance.
The same holds true for individual stocks and actively managed ETFs, or any asset class for that matter. What performed well in the past can quickly revert to the mean with a year of underperformance.
Look no further than the periodic table of investment returns – a brilliant visual on the power of diversification and why performance chasing leads to poor outcomes.
Last year’s winners become this year’s losers, and vice-versa. Making things worse, by the time regular investors shift their portfolios into these winning funds, sectors, or individual stocks, the money has likely already been made.
A better idea is to hold a diversified portfolio of assets so you never have to guess which one will outperform from year-to-year.
3.) What investors need to know today
The Globe and Mail has a long running column called, “what investors need to know today.” I hate it.
It’s great for news junkies who are interested in quarterly earnings reports, IPOs, mergers and acquisitions, inflation expectations, etc. But regular investors don’t *need* to know anything on a daily basis to maintain a sensible portfolio.
One of the main reasons I invest in Vanguard’s All Equity ETF is so that if I pulled a Rip Van Winkle and slept for two decades I could be reasonably confident that I’d end up with a good outcome from my investments.
What can a regular investor glean from a daily newspaper column that might give him an edge trading stocks with professional money managers and computer algorithms? Information is quickly baked into a company’s share price, so unless you have some type of insider knowledge you’re trading on the same information as everyone else. Not helpful.
What investors need to know today circles back to my original point at the top of this article. Stop checking your portfolio so often. Diversify broadly so you get a tighter dispersion of returns rather than the up-and-down roller coaster ride from year-to-year.
And stop chasing performance. Recognize that reversion to the mean will happen. Years of outperformance should lower your expectations for future returns. Similarly, a year of truly bad performance should increase your expectations for future returns.
Again, I don’t know what will happen in 2023, but I’m optimistic that stocks and bonds will have good future returns after a brutal year in 2022.
Investors face countless distractions every year. Whether it’s fear of missing out on this year’s top performing asset, or fear of your existing portfolio losing money, these distractions are designed to make you want to take action (and likely part you from your money).
Meanwhile, a successful investment plan is all about setting up a low cost, risk appropriate portfolio that you can stick to for the long term. That means not getting caught up chasing past performance, be it meme stocks or crypto or tech stocks for that matter. It also means not abandoning ship when global stocks and bonds tumble, as they did in 2022.
Finally, we should also recognize that we’re human and our plans can change. For instance, you might not have sold your equities in a panic this year, but it’s perfectly reasonable if you paused your regular contributions to focus on building up your emergency fund or paying down your mortgage.
My Investing and Trading Activity
Flexibility is the key to any good plan, and it was a theme for me when it came to my investing and trading activity this year. Long-time readers know that I invest my money in Vanguard’s All Equity ETF (VEQT) across all of my accounts except for my kids’ RESP (invested in TD e-Series funds).
But we decided to build a new house earlier this year and wanted to use our TFSA funds as part of the down payment. The decision to build a new home also influenced what we did with our corporate investing account, as we opted to pause these contributions to build up a larger cash cushion just in case.
Here’s what my investing and trading activity looked like in 2022:
RRSP
My wife and I pay ourselves dividends from our small business and so we don’t generate new RRSP contribution room. With both of our RRSPs fully maxed out, these accounts remained invested in Vanguard’s All Equity ETF (VEQT).
That said, I did place one trade in this account when VEQT’s annual distribution was paid in January.
My RRSP is down about 10.5% on the year.
LIRA
A similar story with my locked-in retirement account. This was set up in 2020 after my decision to leave my former employer’s pension plan and take the commuted value. I invested the funds in VEQT and plan to leave it there for the next 20+ years.
That said, I did place one trade in this account when VEQT’s annual distribution was paid in January.
My LIRA is down about 10.5% on the year.
TFSA
I contributed $6,000 to my TFSA in January and bought more units of VEQT in this account. But then we went house shopping and signed a purchase agreement to build a new house.
I sold all 3,300 units of VEQT at the end of January and transferred the proceeds over to an EQ Bank TFSA. I withdrew these funds this summer to make our first deposit on the new house.
VEQT was down about 4.5% on the year when I sold, and then I earned about $500 in interest while the funds were parked at EQ Bank.
Corporate Investment Account
My goal with our corporate investing account was to contribute $4,000 per month and invest in VEQT. The year started out that way, with contributions of $4,000 in January and February. I skipped March and April, and then contributed $16,000 in May, $8,000 in June, and $4,000 in July.
I decided to pause contributions from there. We wanted to build up a bigger cash reserve just in case we had to draw from our company at some point to pay for overages on the new house (not yet!) or if we end up having to carry the mortgage on our existing house for longer than expected. It seems like a prudent move.
Total contributions of $36,000 this year. It’s down about 5% on the year – a better performance than my other accounts thanks to the timing of contributions in the first half of the year.
RESP
This is the account in which I stick to a robotic automated schedule every single year. I contribute $416.66 every month and immediately buy one of four TD e-Series funds (the one lagging its target allocation).
Total contributions of $5,000 (plus $1,000 in government grants). It’s down about 8.75% on the year.
Final Thoughts
There you have it. I placed a total of nine ETF trades this year. One in my RRSP, one in my LIRA, two in my TFSA, and five in my corporate investing account. I placed 12 mutual fund trades in my kids’ RESP – buying more TD e-Series funds.
In a year of extreme market volatility I resisted the urge to deviate from my investment plan. I continue to hold VEQT across all of my account types, aside from my kids’ RESP.
But I did withdraw from my TFSA to make a deposit on our new house purchase. And I did pause regular contributions to my corporate investing account to build up more cash.
I feel like VEQT is still an excellent choice for someone like me who does not want to spend time managing and rebalancing a multi-ETF portfolio. Writing this post even reminded me that I can simplify my RRSP and LIRA even further by turning on automatic dividend reinvestment, saving me from placing one trade a year in those accounts.
And while the globally diversified VEQT will always underperform the top sector, country, or region every year, it will also outperform the worst sector, country, or region every year. It’s that tighter dispersion of returns that helps keep investors like me in their seat and able to stick to their long-term plans.