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RSP'ing your way to retirement...
A Registered Retirement Savings Plan ('RRSP' or 'RSP') provides one of the few ways in which Canadians can shelter their income from taxes. Still, the vast majority of Canadians don't take full advantage of their RSP eligibility. According to Statistics Canada, fewer than one in five Canadians contributed to an RSP in 2006. And the amount they contributed represented only about nine per cent of the total room available.
Some people think of a RSP as something they would purchase. But you don't actually buy a RSP. You open an account called a Registered Retirement Savings Plan and choose which qualified investments you want to buy and hold in the plan. The money you contribute into the plan, no matter what form of qualified investment it is, is a taxable deduction. Returns earned on investments within the plan accumulate on a tax-sheltered basis -- meaning that your investment returns will compound without being crippled by tax -- until you take the money out of the plan, usually at retirement when your income is lower and you therefore pay lower taxes. This is the essence of RSP's..
Building a retirement plan is very similar to building any long-term investment plan. You need to follow certain basics. Once you consider your time horizon, set your goals and evaluate the risk you are prepared to take, you have to choose the investments that will help your plan succeed. Remember, every investment has three key characteristics -- expected return, risk and marketability..
Expected return refers to the amount of interest, dividends or capital gains that you expect to receive from your investment. (Actual returns may, of course, be quite different.) There is a direct relation between expected return and risk. The higher the expected return, the greater the risk..
By defining the expected return, risk and marketability of the investments you are using for your retirement plan, you can more accurately monitor your plan's progress..
Considering that so few Canadians take full advantage of them, are RSP's still a good idea? Absolutely! Where else can a person earning $75,000 a year, paying income taxes at a rate of 35 per cent, put away $10,000 to grow in a tax-sheltered environment plus receive a $3,500 gift in return?.
As one makes their way through retirement, one must remain cognizant of the fact that by December 31st in the year in which an individual attains the age of 71, he or she must convert their RSP to another tax-free investment vehicle. The choice is a life annuity (annuities were covered in a previous column), or a Registered Retirement Income Fund (RRIF). Most retirees choose the RRIF option to retain control over their money..
Inside a RRIF, funds continue to grow without the burden of tax. However RRIF's come with the requirement to withdraw a minimum annual income whether one needs it or not. The amount of the withdrawal is based upon age, and as one grows older, the minimum percentage withdrawal increases. All funds withdrawn from a RRIF are fully taxable as ordinary income. The balance remains within the tax-sheltered investment vehicle until withdrawn..
RSP's are an excellent tool to build a pool of wealth for retirement, especially with companies cutting back on their pension plans, leaving people with fewer opportunities to save. It's crucial that people put something away to supplement their income in their retirement years. For this reason alone RSP's are in the vast majority of cases a wise investment. This is especially true for younger individuals whom have so much time to benefit from compound, tax-sheltered growth..
A strategy to make the savings discipline as easy as possible is to arrange for automatic monthly withdrawals to cover RSP contributions throughout the year rather than investing a single lump sum. That way you maximize your contribution, you incorporate regular withdrawals into your monthly financial routine and you are not tempted to reduce your annual contribution so that you can spend the money elsewhere..
Furthermore, by following this technique, you will benefit from "dollar-cost averaging" (explained in a previous column). Essentially, it forces you to follow the investment principle of "buy low, sell high"..
It is important to bear in mind, that like all investment strategies, it is not a "one size fits all" solution. There are various scenarios when investing in an RSP may not be wise, such as when you are at or near retirement, and you have more than substantial assets already invested in your RSP. Why subject further monies to full taxation upon withdrawal from your RSP? Perhaps a non-registered investment would better serve your interests..
Also, some people question the wisdom of borrowing money to maximize their RSP contribution. In certain circumstances, it may make sense to borrow, and in other circumstances, it may not make sense. It has to fit into your overall financial plan, and you must be sure you have the cash flow to make the repayments..
What course you should follow greatly depends on a number of factors, including how you want to live when you retire; how much money you will need; and what income sources you can tap into..
As always, be sure to consult with a financial advisor to ensure the strategy you embark upon is the one best suited to help you meet your specific retirement objectives..
The information in this article is not intended to constitute tax or legal advice, and it may not be relied upon for such. Please seek specific professional advice prior to embarking upon any strategies discussed herein..
