Why Do RRSP's Get Such a Bad Rep?

Most polls and surveys indicate that most Canadians don't seek any expert advice when looking to become retirement ready. As a result, that's led to the development of many misconceptions regarding the value of investing in a Registered Retirement Savings Plan (RRSP). Many Canadians believe that opening a Tax-Free Savings Account is a significantly better savings vehicle as no tax applies.

There are several reasons that contribute to why RRSPs have such a bad reputation amongst Canadians. One of the most significant reasons is that 39% of the people involved believe there's no real advantage to investing in an RRSP because they'll have to pay back a portion in taxes in the future.

Additionally, another reason why RRSPs are starting to become unpopular is that clients are unclear about the tax implications that might occur after the death of a spouse. Utilizing the RRSP under the guidance of a professional is the best way to ensure that one gets the most out of a savings plan. Here's how to get the most efficient use out of an RRSP.

Maximize Savings by Maximizing Contribution

The best way to get the most out of an RRSP is by fulfilling the allowable contribution limit every year. Those that fail to reach the maximum limit end up accumulating unused RRSP contribution room.

It can be a challenging time covering the maximum limit with just cash, so there are two significant alternatives that can be used. The first alternative is choosing the contribution in kind method; clients with non-registered investments like mutual funds can choose to contribute these to the RRSP

The option is to use borrowing; it's available in the form of an RRSP loan. Banks generally offer a very competitive rate. Even though they must pay initial interest, the long-term benefits far outweigh the interest costs.

Make Contributions Early

Regardless of what field one looks at, procrastination can end up causing a lot of damage. The ideal path to use is making RRSP contributions early. As soon as the money goes into the RRSP, the sooner clients have the option to work on a tax-deferred basis.

Getting all the money together to make the full contribution can be challenging; an alternative contribution plan is making monthly payments. It's a technique that's both simple and powerful at the same time.

Keep an Eye on Annual Tax Refunds

Those clients receiving a potentially large annual tax refund might not be in the position of power they think. A large yearly tax refund means that the clients could be losing out on multiple opportunities in the current period. Tax refunds essentially function the same as an interest-free loan would, and it isn't free money as most people expect.

The Canada Revenue Agency offers a form that allows applicants to reduce the amount of income that the employer withholds. While it's a viable method, getting the necessary advice before making any withdrawals is highly suggested.

Spousal RRSPs

A spousal RRSP is a savings plan that effectively works for one spouse's benefit while the other makes the contributions and deductions.

They're a good strategy if one of the expected spouses falls under the lower tax bracket in retirement. These savings plans become incredibly viable when one spouse is significantly older than the other.

Making Tax-Efficient Deduction Decisions

It may seem like a tactic that goes against the traditional methods, but those expecting a significantly higher income in later years can choose to defer taking the deductions in the current year.

Clients can choose to make their RRSP contribution in the current year and then waiting to claim the deduction until they're in a higher tax bracket.

Always Balance the Portfolio

While the RRSP is a solid investment, the key to a reliable and healthy retirement is ensuring a diversified portfolio of investments.

The best method of mitigating risk and ensuring a smooth retirement is by investing in a variety of different financial instruments. These financial instruments are fixed-income investments and variable income investments.

Points to Ponder

If it can be agreed upon that the tax refund received from a RRSP contribution that drops you to a lower tax bracket is valuable then it stands to reason that if we can make up the tax cost in redemption we are ahead. What this means to the average investor is that we need substantial returns. This leads to two approaches; achieve higher returns with potentially riskier investment strategies or spend more time in the market. One is considerably easier than the other. If you invested in RRSP's and stopped completely 10-15 years prior to retirement and let the time in the market work for you and shifted focused on non-registered investing during that period, you would be well positioned to accomplish being ahead of the future tax bill. If you factor in the larger tax refund in your hands for that same time period, you are even further ahead.

Don't forget, in retirement you still can hold a TFSA and RRIF, which will continue to grow as you withdraw. Understandably, at this point investment strategies would be considerably more conservative, but they should be able to outpace the rising cost of living.

Conclusion

It comes down to the right advice. Are the right investments in your RRSP? Should you calculate your RRIF withdrawal based on your spouses age? Should you redeem sooner? Should you use the one-time over contribution allowance? Should you use your home as a vehicle to withdraw funds from your RRSP?

RRSPs might have a bad reputation; however, clients can truly start taking advantage of this very viable savings plan with the proper guidance.