RRSPs have been around for several decades enabling investors to save for their retirement while deferring taxes paid. Everybody knows the rules by now – or do they?
Here are some common myths and misconceptions about RRSPs.
RRSP Myths
Myth #1: You have to be over the age of 18 to contribute to an RRSP.
Anyone living in Canada who has earned income should file a tax return – regardless of age – to receive contribution room. That includes children with flyer routes, those who babysit, and kids who have promising singing careers.
There’s little point in most children claiming the RRSP deduction because little or no tax will be owed, but the benefits of making a contribution make it worthwhile to file a return.
Related: RRSP or Mortgage – What to do with your Tax Refund?
Consider a 12 year old who makes a $500 contribution each year until age 18 and then stops. At a 5% annual return he will have $33,000 at retirement. Of course, the savings habit will be ingrained early on, and he will be well on his way to a substantial retirement nest egg.
The second benefit is that a child’s RRSP tax deduction can be carried forward indefinitely, so when he does start working full-time, he’ll have deductions he can use to offset the tax on his income then.
This leads us to Myth #2.
Myth #2: You have to claim your RRSP deduction each year.
Most people do take the deduction for their RRSP contribution right away. Sometimes holding off makes more sense.
Related: Is An RRSP Loan Necessary?
Take, for example, someone who goes back to school in September. Since her income for that year will be reduced, her marginal tax rate will also be lower. Claiming the deduction then would result in less of a tax saving.
It would be better to hold the deduction for when she returns to work full time and her taxable income increases.
Myth #3: You can withdraw from a spousal RRSP three years after the deposit
The “3-year rule” is commonly misunderstood. It is not three years after the initial contribution, nor can you withdraw any money while still keeping contributions up to date, without incurring tax in the contributor’s hands.
The rules are based on calendar years.
For example, if you made your Spousal RRSP contribution for the 2010 tax year by December 2010, and it was the last contribution made to that, or any other spousal account, you can withdraw funds as soon as January, 2013.
If you waited until the first 60 days of 2011, you will have to wait until January 2014 – a whole year later – before the withdrawal would be taxed in the plan holders hands.
Related: Should You Make RRSP Contributions If You Have A Pension?
Myth #4: You can no longer contribute to an RRSP if you are over 71
What if you are still generating income? Are you out of luck? Perhaps not.
In early December of your last year to contribute, put in an additional amount, based on your earned income. If that puts you over the $2000 allowable lifetime limit, you will incur a 1% per month fee on the excess RRSP over contribution – just one month – then you can deduct in the subsequent year.
Also, keep in mind that contributions to a spousal RRSP are based on your spouse’s age not yours, so if your spouse is 71 or younger, you can still contribute on his or her behalf and take the tax deduction.
Myth #5: You must convert your entire RRSP to a RRIF when you turn 71
It is true that you must convert your holdings by the end of the year in which you turn 71. You are then required to withdraw a minimum amount each year starting the year after the RRIF is established.
You can, however, convert a portion, or the entire amount at any earlier age.
Many financial institutions charge a fee for regular withdrawals from an RRSP, but not for withdrawals from an RRIF – contact them for a fee schedule.
Related: Do You Have A Locked In RRSP?
There’s not much benefit for converting the funds prior to age 65, unless you need the money. At age 65, though, you can take advantage of the pension income tax credit on your tax return and pension income splitting with your spouse.
Some people keep their RRSP account for further contributions, and just convert enough to their RRIF in order to generate enough income to qualify for the credit.
Income splitting is beneficial when you’re calculating your OAS amount and any potential clawbacks.
I haven’t always been a DIY investor. Like many Canadians, I started investing in mutual funds through a financial advisor at my bank.
I was getting matching RRSP contributions from my employer, up to 2% of my salary each year, but in order to get the match I had to invest through a specific bank – HSBC.
I went to the local branch and filled out the know-your-client form. Because I was young and had a high tolerance for risk, I was steered toward their HSBC Global Equity Fund. One fund, that’s it.
Since I was in early the accumulation phase, I didn’t pay much attention to the abysmal returns I was getting, or the high MER that I was paying. I just set up automatic contributions to come off my paycheque every two weeks and started pouring money in.
Related: Mutual Fund Fees – The High Cost of Canadian Funds
After a few years, I had invested nearly $25,000. But the markets started tanking in 2008, and when I checked my annual statement I saw the value of my investments had dropped below $20,000.
Becoming a DIY Investor
I made a career change the next year, and one of the first things I did was transfer my RRSP portfolio from HSBC to TD Waterhouse. I had researched dividend growth investing and was ready to take control of my investments and become a DIY investor.
The in-kind transfer took a few weeks to set up. Once the transfer was complete, I used the $20,000 to buy eight dividend stocks.
Over the last three years I’ve added $3,900 to my RRSP, and with that, along with the cash accumulating dividends, I’ve added five more stocks to my portfolio and added to existing positions.
Related: Using ETFs Inside Your RRSP
(Since I have a defined benefit pension at my new job, I no longer contribute that much to my RRSP)
Calculating Returns
I haven’t been very diligent in tracking my returns in the past. I found this rate of return calculator from Justin Bender at PWL Capital, which made it easy to calculate my portfolio returns.
All I did was plug-in the total month-end portfolio value from my TD Waterhouse statements, which are available online, and add in my contributions. I was impressed with the results. My DIY investing portfolio has grown from $20,000 to just over $40,000 in a little more than three years.
- 2009: +35.54%
- 2010: +14.23%
- 2011: +9.82%
- 2012: +10.12% (YTD)
Benchmarks
It’s a good idea to regularly track your performance, but unless you’re comparing it to an appropriate benchmark, you won’t really know where you stand.
I looked up the returns from my former HSBC Global Equity Fund to see how it’s done over the past three years. According to Morningstar, this fund returned a total of 9.74% since 2009. But wait, when you factor in the 2.7% annual MER, the fund returned -1.06%.
Related: How To Avoid These 4 Investing Mistakes
What about the S&P/TSX 60 Index? Since July 2009, the main Canadian index had a total return of 20.39%, meaning $20,000 would have grown to just over $24,000 in three years.
The iShares dividend ETF (CDZ) had a total return of 57.58% since July 2009. With this fund, my $20,000 would have grown to $31,516 in three years. If you were to factor in the additional $3,900 in contributions, these returns are more in-line with the performance of my individual stock portfolio.
Final Thoughts
I realize not everyone is cut out for investing on their own, and so many people will look for help from a professional advisor. But it’s important to understand what you’re invested in, and how much it’s costing you, even if you leave the details up to your advisor.
Related: Fee Only Financial Planner Vs. Commission Based Advisor
I’m happy with my decision to become a DIY investor. I’m not saying my approach is perfect; I was extremely lucky to switch to dividend investing at the right time.
I doubt my personal rate of return will be this high going forward, but I know I’m better off now than I was with those expensive equity mutual funds.
While big corporations and governments can have a big impact on the environment – for better or for worse – individual efforts to “go green” can add up too. Here’s how to save money by going green:
Reducing Your Environmental Footprint
You can reduce your environmental footprint and make the planet a cleaner, healthier place – and as a bonus, many of these ideas can help you keep more of your money in your pocket too.
- Avoid excess packaging. Use your own portable coffee mug instead of paper or Styrofoam cups. Take your own reusable bags or bins to grocery stores instead of using their plastic bags. Consider how much packaging is used in your purchases – children’s toys are exceptionally bad – and buy in bulk if it’s appropriate for your family.
- Donate used clothing and household or office items to thrift shops instead of sending them to the landfill. Give your local consignment and thrift stores a chance before heading off to the mall. Brand new and lightly used items can often be found for a fraction of the price of new.
Related: How Many Clothes Do You Need Anyway?
- Recycle. Plastics, metal, glass and paper are obvious recyclables, but you can also recycle things like cell phones and toner cartridges. Look for drop off spots in your neighbourhood, or send them back to the manufacturer if they have this option.
How To Save Money: In the garden
- Plant native grasses, shrubs, trees and flowers that don’t need frequent watering.
- Ban pesticides from your lawn. Keep your grass looking lush naturally – let it grow a little longer and water it deeply but infrequently.
- Compost. If your city doesn’t collect organic waste for composting, install a composting bin in your backyard (or a vermicomposter – a natural worm-based composter – in your apartment kitchen). Mulch grass clippings and raked leaves.
Related: Organic Food Gardening
How To Save Money: Inside your home
Conserve energy with your lighting, heating and cooling, and appliance use.
- Use less water by installing a low-flow showerhead and turning off the tap when you brush your teeth. A running bathrom faucet uses 10 to 20 litres per minute.
- Turn off lights when you leave the room.
- Use fans instead of air-conditioning to fend off summer heat, and close curtains and blinds during the day.
- Install a programmable thermostat and use the timer to automatically reduce the use of heating or air conditioning, especially at night or when the house is empty. Heating and cooling your home accounts for about 60% of your energy costs. A programmable thermostat could reduce your heating bill by 2% (about $75 a year) for every 1 degree Celsius you turn it down.
- Replace incandescent light bulbs with compact fluorescent ones. ENERGY STAR compact fluorescent light bulbs use 75% less energy than incandescent bulbs. Switching all the incandescent light bulbs in your house to compact fluorescent bulbs could save you $250 a year.
- Weatherproof and insulate your home to reduce your heating costs.
- Choose energy-efficient models when you replace appliances. Trading your old basement fridge for a new energy-efficient model could save you more than $100 a year. Switching to a high-efficiency water heater could save you up to $100 on your energy bill each year.
How To Save Money: Getting around
- Take public transit, walk or bike. The fewer cars there are on the road, the lower the emissions and the better our air quality.
- Consider a hybrid or fuel-efficient vehicle for your next car purchase.
Related: Pros And Cons Of Living In The City vs. The Suburbs
Fun Facts
Did you know…?
- If everyone in the Greater Toronto area turned off the tap while brushing their teeth (twice a day) they would collectively save 140 million litres of water – enough to satisfy the daily water requirements of a city of 560,000 people.
- Every day the residents of the City of Ottawa use enough drinking water to fill 2.3 million bathtubs.
- Almost 80% of the earth’s surface is water, but only 1% is fresh water suitable for drinking.
- New flat-screen LCD monitors use 70% less energy than standard monitors – and contain 95% less lead.
Conclusion
Many of these changes are small ones that you can integrate into your lifestyle gradually without noticing much of a sacrifice.
Related: 35 Ways To Save Money
How much you can save by making “green” upgrades to your home depends on variables like the age and size of your house, the climate where you live, and your own personal consumption patterns.
But one thing is certain. If you reduce your energy use, before you know it, you’ll be running a “green” household – and saving money too!