Get the Most Out of Your RRSP
July 28th, 2017
Retirement planning can occupy much of your financial planning thoughts, even when you aren’t running up against the annual deadline for contributing to your Registered Retirement Savings Plan (RRSP).
If you avoid waiting until the last minute, you have a better chance of making smart decisions about how much you want to invest and what you want to invest in. Keep in mind that the sooner you put money into the plan, the longer it has to grow at a compounded rate.
Start planning now and you also can make informed decisions about whether you want to start or continue to contribute to a self directed RRSP and if you want to invest in a Tax Free Savings Account.
Popular Investment of Choice
For more than half of the owners of RRSPs, mutual funds are the investment of choice. And for many that choice is well-suited to their retirement-saving strategy and provides a reasonable rate of return.
Moreover, the funds provide access to the shares of more companies, professional management and reduced valuation risk. Choosing a mutual fund also relieves you of the need to monitor the performance of individual stocks and lets that job fall to the fund managers.
Be sure you inquire about management fees; they can be high. Fund managers are commonly paid with a management expense ratio (MER). That is the percentage of the fund’s assets that goes to the manager before any returns are paid out.
Controlling Your Investment Destiny
If you are the sort of investor who likes to have more control over your investments, you might consider opening a self-directed RRSP. It may provide greater investment flexibility and potentially higher returns, depending on your tolerance for risk.
Most self-directed RRSPs have an annual trustee fee to cover administrative costs. The fee may range from as low as $25 to $250 a year.
To help you determine if the fee is worth it to you, divide it by your portfolio balance. If you are paying $125, or $133.75 with GST, and your portfolio balance is $50,000, the annual fee is 0.27% of the portfolio.
Advantages of Taking Control
Add to that other expenses such as trading costs, transfer out and de-registration fees. Then ask yourself if you consider the money well worth it when weighed against the benefits of directing your own plan. In general, the advantages of taking control of your own RRSP include:
Consolidation: If you have more than one RRSP, you can simplify accounting and make it easier to track your investments by combining them. This can also cut administration costs. You receive a single periodic statement summarizing transactions, income and expenses. Converting to an annuity or Registered Retirement Income Fund is also simpler when you reach 71 and must wind up your RRSP.
Diversification: There are a number of investments that qualify for a self-directed RRSP. You can choose from such conventional vehicles as cash, GICs, bonds, mutual funds and stocks as well as:
- Small business corporations;
- Bonds, savings bonds and debentures guaranteed by the federal government, or a province, municipality or crown corporation;
- Shares and debt of Canadian public companies;
- Certain annuities issued by Canadian companies;
- Call options on Canadian equities or debt traded on a recognized Canadian exchange.
- Debt obligations of corporations with shares trading on an eligible foreign stock exchange; and
- Foreign publicly traded corporations and foreign government bonds with investment grade ratings. There are no restrictions on foreign content.
Caution: There is a currency risk involved when you invest money outside Canada. Individuals over, say, 60 years of age, who will be making withdrawals soon for purchases in Canadian dollars, may want fewer foreign holdings than Canadians with a longer time line.
Mortgages: You can hold your own mortgage in your plan, which means you essentially lend yourself the money and pay it and the interest back to yourself rather than to a lender (see below for a look at how mortgages can boost your contribution limit).
Transfers: As part of your deductible contribution, you can transfer other investments into your plan, or sell them to your plan. If the fair market value at the time of the transfer or sale exceeds your cost, the difference is a capital gain. Capital losses cannot be deducted, so it’s not necessarily a good idea to transfer or sell losing investments.
The options available require you to pay attention to the investments you choose. If a non-qualified investment is put into or bought by your plan, the fair market value will be included in your income. Moreover, any income earned on those investments is taxable.
Potential Problem Areas
Be careful if you plan to consolidate with a spouse’s account. When you combine spousal and regular funds into one account, the plan becomes a spousal RRSP subject to the rules around spousal plans. That means any withdrawals can be taxed in the hands of the contributing spouse to the extent that spouse made contributions in the year of the withdrawal or the preceding two years.
Another difficulty can arise when you give a spouse cash to contribute to his or her own RRSP. If, say, your spouse has no cash for a contribution and you want to offer cash for a contribution, you could face tax on all or part of the withdrawals your spouse makes later.
Canada Revenue Agency deems RRSP as property so any withdrawals may be considered income from property. Attribution rules apply to that income so the law attributes back to you because you gave the cash to acquire the property. Consider an investment loan as an alternative to avoid the attribution. The current prescribed rate on the loan is one per cent.
Set up an appointment with your accountant to discuss potential investments and ways to maximize your retirement savings.
There is a way to increase your retirement savings that may even allow you to exceed the RRSP annual contribution limits. Lend yourself a home loan from your self-directed RRSP.
The main advantage of this strategy is that you may be able to pay yourself a higher rate on the mortgage than you have been able to earn on other low-risk, fixed-income investments. However, the mortgage interest rate could be significantly lower than the return on higher-risk investments.
Your self-directed RRSP is allowed to hold a mortgage on any residential or commercial real estate you own in Canada provided that:
- Cash or cash equivalents in your RRSP equal the amount of the mortgage.
- A lender approved by the National Housing Act administers the mortgage. (The lender will charge fees.)
- The interest rate and terms of the mortgage reflect typical commercial practices.
- The mortgage is insured by the Canada Mortgage and Housing Corporation or by a private mortgage insurer.
With this strategy, your plan lends you the mortgage and you pay it back in regular installments.
As an example, say you have a $200,000 mortgage and the same amount in your RRSP. You use the money in the plan to pay off the mortgage and then make regular mortgage and interest payments to yourself, that is, your RRSP.
If you set up an RRSP mortgage with a 25-year amortization period and you are paying yourself back $1,400 a month, you will eventually contribute more than twice the amount you took out.
This strategy may let you put in more than the allowable RRSP annual contributions. How? Your contribution limit is based on annual income. But when your RRSP holds a mortgage, you must meet the monthly payments regardless of your annual income. They may add up to more than the annual contribution limit.
The rules and regulations governing this strategy are complex. Consult with your accountant.