10 Things You Need To Know About An RRSP
I don't want to discourage anyone from saving, investing our utilizing a Registered Retirement Savings Plans. When utilized properly, RRSPs can be an extremely powerful component of your financial plan. But, when not used properly, they can become detrimental. I believe that, in order to make any decision and expect a good result, you should insist upon both good and full information. Lack of information or knowledge on a topic can lead to less than desirable results. All financial products have good attributes but also negative ones. The following is a list of things you should know before you decide to invest your hard earned money into an RRSP.
- There is a danger that you will be in a higher tax bracket when you withdraw your RRSP than when you make your contribution. Understanding your potential tax brackets at retirement is the most important consideration when investing within your RRSP.
- Tax incentives for taking risk do not apply within a RRSP. When you invest in Equity based investments, there are added risks. Canada Revenue Agency (CRA) recognizes this fact and, as an incentive, taxes earnings on those types of investments at a much lower rate than guaranteed investments. (For example, Capital Gains and Dividend Income can be up to 30-50% lower than regular income.) Within an RRSP, all income is treated as regular income and taxed at your highest marginal tax rate when you retire.
- There are no tax deductions available if/when you lose money on an investment within a RRSP. If you invest money outside of your RRSP and suffer a loss on the investment, CRA will allow you to deduct your loss against other gains allowing you to cushion the blow by not having to pay tax on other equivalent gains. If you suffer a capital loss in your RRSP, there is no offsetting provision. The loss is yours and yours alone.
- Investment management fees are not tax deductible within a RRSP. If you invest money outside of an RRSP, there are tax deductions available for some of the investment fees you pay. You could have the same portfolio and applicable fees with your RRSP but you may not deduct those fees.
- Speaking of fees, financial institutions charge fees based on the value of your account. Since you are deferring income to the future, you are able to sock away a lot more money in an RRSP than you would in a non-registered portfolio. In fact, up to 100% more if you are in a 50% tax bracket. If your portfolio is twice as large as what you could create under a non-registered scenario, the fees payable to your financial institution are also 100% higher. Make sure the advice you are receiving isn’t being driven by the fees collected on your account!
- Using your RRSP as collateral for a loan is not likely an option. Let’s say you want to borrow money for a new business venture, an investment or even a vacation property. Your lender may require you to provide collateral for that loan. Since your RRSP is 100% taxable when surrendered, most lenders will not allow you to use your RRSP as a pledge against a loan. Don’t build your entire net worth in your RRSP.
- RRSP income can be detrimental to your Old Age Security (OAS). The maximum Old Age Security benefit for seniors 65 and over today is $6,846.24 per year. However, depending on your annual taxable income, you may have to pay some or all of that back to CRA. Otherwise known as the 'OAS Clawback', when your taxable income exceeds $72,809, CRA starts to take back the OAS benefit in the form of an additional tax during retirement.
- Forced taxation - deferral of income is potentially the greatest advantage of an RRSP. However, all good things must come to an end and, for the RRSP, this begins January 1st, the year you turn 72. CRA mandates that you convert your RRSP to an income vehicle at that age. In essence, you will be required to surrender a portion of your RRSP savings every year through your retirement as outlined by a schedule set out by CRA. This is their way of collecting taxes on the accounts they have a vested interest in. Whether or not you require the income, you will be forced to pay taxes on your RRSP savings beginning the year you turn 72.
- Your estate matters! When you pass away, your spouse can inherit your RRSP free of tax assuming that they are the beneficiary. But once they pass 100% of the value of the RRSP becomes taxable on their date of death. It is not unusual for an RRSP to be worth several hundred thousands of dollars on that date. The highest tax bracket in Ontario has just been increased to 53.53%. That means potentially over 50% of your RRSP could be lost to taxation upon death. While the purpose of an RRSP is to provide retirement income, it should be noted that the RRSP is a very ineffective estate planning tool.
- Know who is in control of your RRSPs. When it comes to your RRSP, there are a multitude of interested parties. There is you, maybe a financial advisor, a financial institution and, of course, Canada Revenue Agency. Make sure you understand the value proposition that each party is receiving.
Don't let this list scare you off RRSPs! That isn’t the purpose of this list. When used properly, RRSPs can be one of the most powerful vehicles in your financial model. The key to success is to know how and when to deploy RRSPs, and also when to surrender the investments so that you can take full advantage of our tax system. Investing in programs without any regard to an exit strategy is a plan based on hope and could leave you vulnerable to unintended results.
Reprinted with permission from the author: John Stregger, Discovery Wealth Management