RRSPs

The concept of RRSPs (Registered Retirement Savings Plans) is simple--put away savings now and postpone the tax to a later date. Some advisors call using this strategy “saving tax”, but the tax is paid when you withdraw the cash. It is simply tax postponement! Not tax savings!

What they are
RRSPs were established in 1957 (An idea from the Equitable Life Insurance Company of Canada).

They are a registered savings vehicle in which you can put investments or savings to: receive tax postponement tax sheltered gains. meaning any gains earned by your investments are not taxed until you withdraw the money.

Setting an RRSP Up
You register a savings plan with the government, choose your investments, make weekly, monthly or an annual contributions and the amount of the deposit is subtracted from your taxable income for that year.

RRSP Regulations
Investments inside an RRSP must be qualified by the government (meaning only qualified investments are allowed) Example:

Legitimate investments are:

• Money Markets
• Mutual Funds
• Segregated Funds
• Exchanged Traded Funds (ETFs)
• Stocks
• Bonds
• Precious Metals

What is the most you can contribute to an RRSP

• Contributions are a percentage of earned income (that is money earned from working), subject a yearly increasing maximum.
• If you don’t make your maximum contribution in a year the difference is carried forward and added to your “RRSP room” each year. If you make a massive contribution to the RRSP in a given year, which totally eliminates your tax owning -- you will be assessed Alternative Minimum Tax (AMT).

Being a registered account RRSPs have rules. The number one rule is: “your RRSP must end the year you turn 71. It must be converted to:

• Cash
• An Annuity
• A RRIF

What happens when you contribute to an RRSP
Your RRSP contribution manufactures a tax refund equal to your Marginal Tax Rate (MTR). If your MTR is 25% you would receive a refund of 25 cents on the dollar. A 40% MTR would give you 40 cents o the dollar. (As you can see the program helps those in the highest MTR--the most!)

In the early years (when insane Marginal Tax Rates of over 50% existed). You could put money into an RRSP and get back a tax refund of 51 cents on the dollar (in Ontario). With the idea that you would be withdrawing the funds at retirement and paying the tax at an MTR of 25%. This seemed like a very good deal!

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Who can contribute to an RRSP
Anyone who has earned income can contribute to an RRSP.

Who can’t contribute
Anyone who has no earned income can not contribute to an RRSP. Investment, disability, rental, interest income, lottery winnings, or gifts may not be contributed to an RRSP. (except in the case of available “RRSP contribution room)

Example:You become totally disabled and can longer work to receive an income. Your employer provided you with quality group Disability Insurance (DI). You have enough to live on, but the DI coverage ends at age 65 and you want to fund your RRSP. You can’t. Disability payments are not earned income.


What is an RRSP Meltdown?

Are there any unfavorable aspects to an RRSP?
The most glaring issue with an RRSP is the potential for “Double Taxation”. At age 71 you must begin withdrawals from an RRSP in one of 3 ways:

1. total withdrawal and pay all tax owing at once
2. convert the RRSP to an Insurance annuity
3. convert the RRSP to a Registered Retirement Income Fund (RRIF)

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RRSPs are NOT for everyone!

RRSPs are an important tool, but as with all tools you need to use the right tool for the job. Would you use a hammer where you should be using a screwdriver? That's why it's so important to deal with a financial planner not just an investment advisor.

Richard Shillington is a PhD. statistician with the C.D. Howe institute. He has written extensively about about government policy, especially the impact of RRSPs on lower income Canadians.

He points it is very easy to set up what he calls a futile RRSP and very few advisors are pointing out this could happen to you.

Today the majority of Canadians put their RRSP contributions away at between 30 to 40 percent MTR. If you run the numbers out to retirement, it shows most people will still be in a 30 - 40 percent MTR at retirement.

This means you will pay tax at the same rate in retirement as when you were working. (Many advisors will that this is still a fair trade as these people got the benefit of tax-free compounding so this issue should not matter!)

Butt, It does matter and here is why; Canadians face a government means test at retirement in regard to government benefits such as Old Age Security (OAS) and Guaranteed Income Supplement (GIS).

Many of those with find that accordingly to the government--they have “too much income” will have some or all of their government benefits “clawed back” (reduced).

These benefits are indexed to inflation (as inflation increases so will your monthly payment). If you inadvertently create a “Claw-back”--this means you are trading non-indexed money (RRSPs) for guaranteed payments that can not decrease or end. BAD MOVE!

What happens is you are first taxed on an RRSP withdrawal and then your government benefits “clawed back” because of this income--this is double taxation--pure and simple!

This combination of tax and claw-back means less money in you pocket than if you had no RRSP at all.

If you - like most Canadians- You have struggled to put a few dollars away in a Registered Retirement Savings Plan at the Bank.

You may have put away just enough to shoot yourself in the foot when it comes to your retirement income.

Funding an RRSP may reduce the cash you have to live on in retirement and the only way to find out is to have a advisor that understands the connection between RRSPs and government benefits--run the numbers!

When can you withdraw from an RRSP
RRSP withdrawals can be made at any time (less the tax at your full marginal rate).

How long can you fund an RRSP?
Until your contribution room runs out and/or you reach age 71, at that point a government calculated minimum withdrawal amounts kick in.

What other Benefits does an RRSP provide?
An RRSP is a very convenient way to save up the down payment for a house. The government allows each taxpayer the opportunity to withdraw up $25,000 from an RRSP account for the purpose of a first time home purchase. You and your spouse are entitled to a total $50,000 withdrawal ($25,000 each) for use as a down payment.

You may also access the funds as a way to finance your continuing education through the Lifelong Learning Plan. Which allows for up to a $10,000 yearly withdrawal to a total of $20,000 for continuing education.

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Look at what many well known financial experts have said:

• "RRSP bombshell: Have Canadians been victims of a fraud?" Gordon Pape - 50Plus - August 2003.
• "RRSPs considered a waste for some" Angela Barnes - Globe and Mail - April 23, 2003
• “Some savers may be better off without an RRSP" Ellen Roseman - Toronto Star - 2003

As you can see not everyone believes RRSPs are good or even needed for every person.

The reason is simple, current rules will cause two things:

• Your RRIF to be depleted leaving older clients with a zero balance account very late in life.
• And the strong possibility of losing some or all government benefits to claw-backs.

This is why so many financial gurus and advisors are recommending an RRSP “meltdown” before age 65.

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