The hair-raising twists, turns and dips that greeted stock market investors in early 2008 have done nothing to create a calm investing climate as Canadians ponder where to put this year's RRSP contribution. Early indications from the mutual fund industry showed that people were stampeding into safe money market funds in January, preferring to wait out the turmoil in the markets.

Changes for 2007 tax year:

Maximum RRSP contribution is lesser of 18% of earned income or $19,000

Pension splitting for seniors is allowed

Deadline for RRSP conversion changed from age 69 to 71

The braver investors are searching for beaten-down stocks or they'll look for sectors that they think will better withstand an economic downturn. Business shows and the financial sections are full of tips. If in doubt, you can always park your RRSP contribution in cash or some ultra-safe investment until the volatility blows over.

But if this year is like most, only about a quarter of us will actually make any RRSP contribution at all. That's a shame because the RRSP is, for most Canadians, a pretty amazing savings vehicle. People in other nations drool over the tax benefits and wonder why more of us don't take advantage of it. An article in Forbes.com (headlined "Canadians eschew billions in free money") pointed out that, despite the immediate tax break and the tax-free compounding in RRSPs, Canadians have only contributed seven per cent of what they could. "The government offers them billions of dollars of free money and they turn their back on it," the author marvelled.

Goodness knows the RRSP industry tries everything to get us to make those contributions. The annual barrage of RRSP-related advertising is well underway and the RRSP forces are in blitz mode, trying to persuade us that they — the financial planning firms, the mutual fund companies, the discount brokers, the banks, the insurance companies — are the ones who can best nurture your precious retirement money (and reap the commissions in the process).

So what are you going to do this year? For those who have yet to decide what move to make (if any), we review the nuts and bolts, and offer some suggestions on what's become an annual rite of financial passage for millions of Canadians.

Why should I 'RRSP'?

The RRSP is really nothing more than a special kind of box. It's designed to hold investments in a registered account so they can build tax-free until they're withdrawn. You can have as many RRSPs as you want, although it's better to have fewer for ease of management and to minimize fees.

Since contributions are tax-deductible, they'll be more valuable to those with higher incomes. Once inside the tax-sheltered environment, the investments can grow faster than they would outside an RRSP, where there would be a tax on gains.

You can put your money into a wide variety of investments — GICs, mutual funds, bonds, exchange-traded funds (which track market indices like the S&P/TSX 60 index), mortgage-backed securities, income trusts and stocks. You can even invest in gold and silver bullion and bars. The old foreign-content rule, which used to limit the amount of money you could put into foreign investments, has also been scrapped.

If you don't have cash to make a contribution, you can arrange a contribution-in-kind. If you hold securities or Canada Savings Bonds outside your RRSP and don't want to sell them, you can put them directly into your RRSP and get a tax deduction for their current value. Note that if the security has increased in value from when you bought it, you must declare a capital gain. But if it's gone down in value, you can't claim a capital loss.

Financial experts always advise people to automatically pay yourself first. In other words, it's easier to put $200 a month into an RRSP than to come up with $2,400 once a year. Monthly saving also allows you to dollar-cost-average your purchases — the same $200 will buy more units of a mutual fund when unit prices are low, and fewer units when prices are high.

QUICK FACTS

Number of Canadians who contributed to an RRSP in 2006: 6.2 million

Median contribution: $2,730

Source: Statistics Canada

Thanks to last year's federal budget, you can continue to contribute to an RRSP until the end of the year in which you turn 71, provided you still have earned income. That's a two-year extension from the old deadline. Once you hit that deadline, you have three choices: 1) convert your RRSP into a Registered Retirement Income Fund (the most popular option), 2) buy an annuity (best when interest rates are higher), or 3) withdraw it in cash (generally not a good idea as you'll pay tax on the whole amount and won't have a retirement income).

The 2007 tax year also marks the first occasion for senior citizen couples to split their pension income. Seniors can now allocate up to half of their eligible pension income to their spouse or common-law partner. Eligible pension income includes company pension plan payments, RRIF payments and annuity income. There's a new form to file to make this allocation: Form T1032 - Joint Election to Split Pension Income. The Canada Revenue Agency has a useful section on its website that answers many pension-splitting questions.

Some people wonder if the new pension-splitting provision makes spousal RRSPs obsolete. Financial advisers say there's still a place for spousal plans because the pension splitting provision is primarily designed for couples over the age of 65. If you want to split retirement income before age 65, a spousal RRSP may still be the best idea. With spousal RRSPs, the higher-income spouse makes a contribution to the other spouse's RRSP. The contributor gets the tax deduction, but the money is now owned by the other spouse. So when the money is withdrawn from the spousal RRSP, it's taxed at the lower-income spouse's rate.

If you don't have a company pension plan, you may want to be more conservative in your investing. If you're not far from retirement, you may also want to be more conservative. Be sure you know what your risk tolerance is.

What's the deadline?

There is none. Well, that's a bit of a trick question. You can make a contribution at any time. The only RRSP deadline you face is if you want the tax break applied to your 2007 income. In that case, the deadline is midnight, Friday, Feb. 29, 2008. But you can always carry forward unused RRSP contribution room to next year, or the year after that, and so on.

The thing about an annual carry-forward, of course, is that they can quickly mushroom into a mountain of room that will stay unused unless you win a lottery or get an inheritance. If you can't muster $2,000 this year, will you be able to find $4,000 next year, or $6,000 the year after that?

One way to contribute more to your RRSP is by borrowing the money. RRSP loan rates are usually very low. For those with a large amount of contribution room, some banks offer catch-up loans of up to $50,000 over 10 years. Check to see if this is appropriate for you.

"Consider over-contributing to your RRSP by the permitted $2,000 penalty-free amount," suggests the accounting firm Ernst & Young. "You won't get a tax deduction for the extra amount, but your earnings on it will grow tax-free."

How much can I contribute?

For the 2007 tax year, people can contribute up to 18 per cent of their earned income from the previous year, up to a maximum of $19,000.

But the contribution calculation isn't that simple. From that figure, you must subtract your pension adjustment (PA). If you're a member of a pension plan at work, you'll have a pension adjustment. This amount takes into account the money you and/or your company contributed to an employer-sponsored pension plan. Your T4 slip records the pension adjustment figure.

To this figure, you must then add the total carry-forward of unused RRSP contribution room since 1991. For some taxpayers who haven't been stuffing their RRSPs, this can amount to more than $100,000.

There's an easy way to find this figure without doing all the calculations. Just check the Notice of Assessment you got from the Canada Revenue Agency last year, or phone the tax department's T.I.P.S. line at 1-800-267-6999. You will be asked to provide your social insurance number, your month and year of birth, and the total income you reported on line 150 of your 2006 return.

While there seems to be enormous pressure for everyone to contribute to RRSPs, there may well be a better way to use your money. For those with a lot of high-interest credit-card debt, it may be better to pay that off first.

Are RRSPs only for retirement?

While RRSP stands for Registered Retirement Savings Plan, the government has brought in two provisions that allow Canadians to access RRSP money for reasons other than their golden years.

The Home Buyers Plan (HBP) has been enormously popular in Canada, with almost 1.4 million people taking advantage of it as of 2004. Since 1992, more than $14 billion has been withdrawn. As long as the money is used to buy a qualifying home, no tax is paid on the withdrawal. The catch is that the money must be repaid to your RRSP over the next 15 years or the minimum annual payment will be added to your income and you will pay tax on that. And the repayment is not tax-deductible (you got the tax break the first time you put in the money). The full rules are complex, so check with the Canada Revenue Agency and your financial adviser.

The Lifelong Learning Plan (LLP) allows Canadians to pull up to $20,000 from their RRSPs to head back to school. The withdrawals can be a maximum of $10,000 in any one year and can be spread over four years. Repayment is on a 10-year schedule. Again, familiarize yourself with the rules and limitations and seek financial advice before doing anything. About 49,000 people have withdrawn $363 million since the LLP began in 1999.

Financial experts also point out that by raiding your RRSP for either of these plans, you lose much of the tax-free compound interest you could have made on that money, so you might want to repay the money quicker than the prescribed schedules.

Recent figures show that growing numbers of Canadians are raiding their RRSPs long before retirement. Often, the reasons for early dipping have nothing to do with buying a home or going back to school. Some people set up an RRSP and collapse it a few years down the road to finance a year of travel. They reason that they got the tax break when they made the contribution, and then will pay less tax on the withdrawal, assuming they have little or no other income that year. While that's true, the experts point out that this kind of withdrawal, unlike those made under the HBP or LLP, cannot be made up in future years. Those contributions, and the gains they would have earned, will be lost forever.

Avoiding the 'cat food' retirement

There was a time when financial institutions used to scare people into making RRSP contributions by showing how much they'd need to save to have a secure retirement. The problem was, the amounts were so large that some people threw up their hands and said, "Why bother?"

Financial advisers point out that anything saved is better than nothing. But for those without a company pension plan, a more-than-subsistence retirement (retirement benefits from the Canada Pension Plan and the Old Age Security program) will require some kind of saving. RRSPs are not the only way of saving for retirement, of course. But for most Canadians, they're the best way.

Trying to figure out if you're on track for the "cat food" retirement is a lot easier these days. Your adviser can provide a detailed projection of where you're heading. If he/she can't provide this, find another adviser. You can also check out some of the many retirement calculators on the internet. If you're mortgage-free and you're not planning to do a lot of travel, you may be able to get by on 50 per cent of your pre-retirement income. But if you're planning a very active retirement, aim for 70 per cent or more.

Retirement becomes a lot easier if you've paid off your mortgage, or if you have a pension plan at work, especially an indexed one that provides guaranteed benefits. But 60 per cent of Canadian workers don't have employer-sponsored pension plans. For those with no retirement income except government benefits, RRSPs and additional savings will make a huge lifestyle difference.

Those on very low incomes should also be aware that RRIF payouts after an RRSP has matured are fully taxable. Those payments may result in clawbacks of the Guaranteed Income Supplement given to low-income seniors, so RRSPs may not be the best choice for those at the lower end of the income spectrum.

Those with retirement incomes above $63,500 should also be aware that Old Age Security benefits begin to be clawed back at that level. Financial advisers often suggest that those expecting a healthy retirement income put money in non-registered investments, as dividend income and capital gains are taxed more favourably than RRIF income.

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