February is the start of so called Registered Retirement, Savings Plan season.  Every type of investment house is running adds about contributing to your RRSP.  (Note most Credit Unions have access to Mutual Funds, but are not allowed to advertise that fact.)  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.  There are basically two types of RRSPs.  The Professionally managed, and the Self Directed.

If you go to the Bank or Mutual Fund company and talk to, and buy through, one of their reps, then you are into a professionally managed fund.  Remember their mission is to not loose you too much money!! Their mission is NOT to make you the most money they can!!  You will also loose a portion of the Funds value to pay all the fees involves.  This is called the Management Expense Ratio, or MER.

Then there is the Self Directed option.  This is the one the Banks and Mutual Fund companies will try and scare you out of.  This option is definitely more work and responsibility on your part.  But if done right, you will make far more than with the professionally managed Fund.  This normally would entail you setting up an online trading RRSP account.  (It takes about 30 minutes at most banks or Credit Unions.)  In a Self Directed account, YOU make all the decisions as to what types of  investments you hold, and how long you hold them. The choice is yours.

Many companies that don’t offer a Pension plan (and some that do) will contribute to your RRSP at some percentage of how much you contribute.  This is definitely something to take advantage of.  If the company gives you $1.00 for each $1.00 you contribute, this is a 100% return on your investment.  This is worth taking advantage of.  Companies only deal with Professionally managed Funds.  I have never seen one that will/can contribute to your Self Directed Fund.

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.  Ted takes $150.00 from his paycheque and puts it into the RRSP account.  At the end of the year, Ted is able to claim that contribution as a tax deduction.  This might get him an income tax refund equal to the income tax on his contributed amount.  If Ted is smart, he will use his tax refund as a new RRSP contribution, or pay off some high interest debt.

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 a while, and need money from your RRSP, it is not easy to get quickly, and has 2 drawbacks.

The first is, that depending on the amount you take out, there is a withholding of either 10% or 30%.  So, if you take out $10,000.00 you will only get $7000.00.  Secondly you will have to declare the whole $10,000 as income.  Since EI is based on your income, there is a possibility that you might have to pay back some of the EI you 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 is not worth it.  If you use it for an Income property you can not follow the same rules as with a First time home purchase.  (Unless you are living in one of the units.)

The types of investments you hold in your RRSP are 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, and a monthly payout.

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 levels.  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 again, 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.  Every Fund company has some good funds.  If you have a Self Directed RRSP, you can buy only the best Funds from each company.

As I have gotten older, I have changed the investments in my RRSP over to Canadian Dividend Paying stocks.  This gives me monthly income, and dividends get better tax treatment than interest.  I hold all my big potential winning stocks in my TFSA.  There is a post about TFSA’s on this site.

RRSPs are a popular 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.