Tis the season for registered retirement savings plans. With the March 1 deadline approaching, we breakdown what you think you know about RRSPs and what the reality actually is.
Myth #1: You need to redeem all of your RRSPs when you turn 71.
“A lot of people think that they’ve got to cash the whole thing out when turn 71,” says Calgary-based Edward Jones financial advisor Scott Gerlitz. “That’s not so.”
True, by the end of the year you turn 71 you are required by law to terminate your RRSP and convert it into some form of retirement income. But converting it all to cash is just one option, the others being converting it to an registered retirement income fund (RIFF) or using the funds to buy annuities. “You can continue to hold the same investment and continue to have growth when you convert to a RRIF. You are required to take out a tiered withdrawal and every year the amount Revenue Canada makes you withdraw goes up. But you don’t have to cash it out all at once.”
Like an RRSP, income earned in a RRIF is allowed to accumulate tax-free.
Myth #2: There’s no point contributing to RRSPs because I’m going to have to pay tax on them anyway.
“Many people have the mindset of ‘Why bother? It’s all going to go to taxes,’” notes Evan Hickey, financial planner at RBC Financial Planning in Halifax. “RRSPs are a tax-deferral vehicle, not a tax-avoidance vehicle. You’re getting a tax deduction against your current income level, and when take it out the assumption is you’ll be in a lower tax bracket,” and therefore will pay lower taxes on them.
Myth #3: RRSPs are too inconvenient if I end up needing cash.
“I hear this a lot: ‘I hate RRSPs,’ Gerlitz says. ‘People will say, ‘Well, I put money in but then I needed money. Then I had to withdraw it and then had to pay taxes.’
‘The point is RRSPs are not a poor vehicle; the point is the advice given [to redeem] was not the best given the circumstances. Everyone should have a money air bag of six to 12 months’ worth of expenses. That alleviates the need to withdraw RRSPs. RRSPs are a long-term vehicle; they’re not intended to solve short-term needs.”
Myth #4: I’m too old to contribute to RRSPs.
“I’ve had people say, ‘I’m in my 50s. Why would I start? It’s too late,’” Hickey says. “It’s never too late, and a little can turn out to be a lot. It’s about getting into the habit of saving. You can put away $100 a month then after a year increase that by $25 a month.”
Myth #5: RRSPs are a poor vehicle because you can’t write off losses.
If you have money in non-registered stocks and the value goes down, you can claim that loss against future gains. Not so with RRSPs. “But people forget you don’t pay any taxes on gains in RRSPs,” unlike gains earned in other types of investments, Gerlitz notes.
Myth #6: Tax-free savings accounts are a better choice than RRSPs since they’re tax-sheltered.
“They’re apples and oranges,” Gerlitz says. “In a perfect world families would be able to max out RRSPs, and my strategy is to take the [income-tax] refund and put it in a TFSA.”
Plus, the contribution limits are different: people can put up to $5,500 into TFSAs per year, while the 2012 RRSP limit is $22,970. Unused contribution room can be carried forward with both, ending at age 71 for RRSPs.
“The advantage of RRSPs is the tax-deferred, tax-sheltered growth,” Hickey says. “Then you can decide what to do with the tax refund. Some people take that and spend on a trip or pay it against mortgage or put it toward higher-interest debt. Or they contribute again to RRSPs or a TFSA or another investment vehicle.”