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RRSP season
- January 23, 2008 2:46 PM |
- By Your Voice
With a market steeped in volatility, many Canadians are paying particular attention to their investments this RRSP season.
How will your savings be affected by the market? What can you do to make the best decisions for your future, now?
Michael Hlinka
On Friday, January 25 CBC Radio and Televsion business commentator Michael Hlinka took your questions on RRSPs.
Read his responses below.
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Comments (22)
Is there a downside to contributing to RRSP's?
Michael Hlinka: Hi Mark,
There may be — in very limited circumstances.
If you are a low-income Canadian and you believe that your RRSP will NOT exceed, say, $30,000 (more or less) in your retirement years, then having an RRSP may mean that you will not enjoy all the government programs designed for low-income Canadians.
However, if you are planning to save for your retirement, the RRSP is the most tax-efficient vehicle there is given the alternatives out there.
If possible should we always contribute the maximum RRSP allowable?
Michael Hlinka: The answer to this may very well be “no,” and here’s the reason why.
Believe it or not, some Canadians “over-save!” Most financial planners expect that, in retirement, our income needs are about two-thirds of what they were when we were actually setting the alarm, getting up in the morning, etc., etc., etc.
Therefore, based on reasonable assumptions about 1) what age you plan to retire at and 2) an estimate about life expectancy, I would strongly recommend that you sit down with someone (a Personal Banker at your local Bank Branch can help and there is no charge) and work out how much money you require to have a comfortable retirement. And in this calculation, don’t forget about Canada Pension Plan benefits and Old Age Security!
Are there viable alternatives to RRSP's?
Michael Hlinka: Hi Hannah,
The only viable alternative is a workplace sponsored pension plan. Similar to an RRSP, it allows you to take deductions against your income (for the part you contribute) and it allows the growth in the plan to accumulate tax-free.
I’m assuming that you are NOT in a workplace sponsored pension plan. And if you are not, there really is no better way to save for retirement for most Canadians than with an RRSP.
Here’s why: When you put money into an RRSP, it lowers your tax burden in the current year. And as you make money, there are no tax implications which means that it can compound and compound and compound!
How much should I contribute to my RRSP to avoid paying additional taxes this year? Is there a formula I can use?
Michael Hlinka: This is particular to each individual.
If you know how much you are going to make this year (which you should) you can “work backwards.” Let’s say that your income is $50,000. The combined marginal tax rate in the Province of Ontario works out to about 35%. Therefore, if you put in $5,000, it would reduce your tax burden by about $1,750.
But I’d stress that this calculation is unique for EACH investor depending on a variety of factors, including income, exemptions and the nature of the income. What I can tell you for sure is that each dollar of RSP contributions DOES reduce your current tax burden — but make sure you respect the maximum limits imposed by the government!
Will the current market volatility benefit or negatively impact the average RRSP in the long term? I keep hearing investment advisors say that there are great deals to be had right now and I assume that RRSP managers are taking advantage of these "deals", is this assumption correct.
Michael Hlinka: Hi Jay,
If you are contributing regularly to an RRSP and have a long-term time horizon, ironically enough dips are good. Here’s the logic why.
Let’s say that right now a mutual fund unit is $10. My $100 contribution buys 10 of them and I expect that if the market performs as expected, the units will be worth $80 in about 20 years. (This is normal growth — the stock market tends to double every seven years or so.) So my $100 contribution grows to $800. Now there's a downdraft and instead of my $100 contribution buying 10 units at $10, it buys $11 units at $9. Now if they’re worth $80 per unit, I’ve got $880 instead of $800.
It’s counter-intuitive — but the numbers bear it out. assuming that you are disciplined enough to buy the dips!
Should RRSPs be the only type of retirement investment I look at? What about stocks and bonds?
Michael Hlinka: Hi Regina,
An RRSP is a specific type of plan. Stocks and bonds are types of products that I can put in the plan.
Think of a glass. In a glass, you can put different things: Fluids like water and milk and I put loose change in mine! The glass is the RRSP. What you put in it are the stocks and bonds.
The unique benefit of an RRSP plan is that when you put money into it, it reduces your taxable income in the current year. And then as you make money in the plan, you’re not subject to tax. You do get taxed on withdrawal, but not until then.
Most financial planners suggest a balanced portfolio with stocks and bonds. Over time, stocks have the highest expected return, but they come with the most risk. Bonds are more stable, but provide lower returns.
I'm currently on 2nd year of owning my first house with my wife. I have used almost all of my RRSPs to avail of the government's HBP on purchasing the house. How do I repay the RRSPs that I've withdrawn? Do I have to buy RRSPs from the same financial institution I've bought my RRSPs originally?
Thanks!
Michael Hlinka: Hi Mr. Aragon,
Under the terms of the HBP, you are REQUIRED to “pay yourself back” in regular installments. You should contact the holder of the RRSP and they will provide you with the details how to accomplish this. After honouring this requirement, you are free to have any other RRSPs with any other licensed carrier.
I am 23, and have been in the professional workforce for about 6 months. I have no savings or investments, but RRSPs seem like a good place to start. I am wondering what options are available to young people who may not have a lot of cash to contribute in a lump sum at tax time to their RRSP portfolio (I have a hefty student line of credit to pay off), but still want to invest in their future?
Michael Hlinka: Hi,
The plan I would recommend for a young person such as yourself is to set up a monthly withdrawal plan. It can be as little as $50 every three months and you can set up such a plan either through the Chartered Bank where you hold your savings and checking account or directly with a Mutual Fund Company.
Good luck with your savings!
If I was a farmer why would I invest in RRSP's when I can make more money investing in livestock (cows, sheep, etc...)
How do you convince the farmer to invest in RRSP's?
Michael Hlinka: Hi Christopher,
Great question!
To anyone who is thinking that they can make more money outside an RRSP I would say the following: Will you make more on an after-tax basis? Because the growth in an RRSP occurs tax free? Will your return on livestock reduce your current tax burden, because RRSP contributions will do that? Are you diversified — that is — have you spread out your eggs among a number of baskets?
By the way, if you are sure that you can make more, lots and lots more, in livestock, then it could be the correct decision. Just accept that there may also be higher risk going down this road.
For those who put off contributing to RRSPs earlier in life, what advice could offer to get these people (and I fall under this category) on track for?
Michael Hlinka: Hi Andy,
I’d just say that you shouldn’t lose sight of the benefits of RRSP investing: reducing taxes now and tax-sheltering the growth of income. You can’t turn back the clock, but it doesn’t mean that if you currently regret the decision, you’ll regret it any less by delaying further.
Should I be worried about contributing all of my RRSP's to a pre-determined Aggressive plan at this time? I am in my mid twenties.
Michael Hlinka: Hi Justin,
You can “afford” to invest aggressively given your age — here’s nice rule-of-thumb to guide you in your decision.
The riskiest, most aggressive investment is putting money in the stock market. To determine what percent your portfolio should be in stocks, subtract your age from the number 100 — in your case it would be 75. And 75% is the amount you should have in stocks (more or less) with most of the remainder in bonds and just a little bit in cash.
As well, I’d recommend that you make regular monthly contributions so that you don’t time the market. Then let time and compounding do the rest!
We have always maxed out our RSP contributions and are now afraid to contribute this year due to market viability.
Is it wiser at this time to pay down the mortgage rather than to risk making RSP contributions?
Is there any way to make contributions to that will not be as risky?
Michael Hlinka: Hi Kathy,
I understand your concern — but here’s something you may not realize.
You can put money into an RRSP and NOT purchase mutual fund units, instead letting it sit in cash until things calm down a bit. You don’t have to invest your money in the stock market right away and in fact you don’t have to invest in the stock market at all if you don’t want to. If you have a Financial Planner, ask him to explain the investment options out there, because there are many when it comes to products allowable in an RRSP plan.
Are the interest payments from RRSP loans and regular loans/line of credit for investment purposes tax deductible?
If I borrow and invest in a savings account is the interest payment tax deductible?
Thanks
Sam
Michael Hlinka: Hi Sam,
The government says the following: If you borrow money and the gains you make are tax-sheltered (as in an RRSP plan) you cannot deduct the interest. If you borrow money and the gains you make are NOT tax-sheltered, you can deduct the interest from gains made on those investments. Which means the answer to your first question is “no” and the answer to your second question (as I understand it) is “yes.”
I am already contributing to a pension fund as a government employee, is it still advisable to contribute to an RRSP in addition to this?
Michael Hlinka: Hi Josh,
This is a tough call. It really depends on how much money you expect to have from your pension at retirement, and how you envision your lifestyle in retirement.
Here’s what I would do if I were you. Call your Pension Administrator and ask them what they estimate you’ll receive at retirement. Let’s say that they said in 20 years you can expect $50,000 per year. Remember to adjust that amount for inflation which should average about 3% or so over the next 20 years, which means your $50,000 will actually have about $28,000 of buying power.
Then you can intelligently determine whether you would like to save more for the future, or enjoy the present more!
Can I put my RRSP contributions into mutual funds and then at a later date, cash out and reinvest the proceeds without incurring any penalties?
Michael Hlinka: Hi Matt,
Great question!
In order to avoid penalties, you MUST either purchase what are called “no-load” mutual funds or “front-end” loaded mutual funds which have a load of 0%.
Most financial advisors encourage their clients to purchase “back-end” loaded funds because if they do so, the financial advisor receives a hefty commission, about 5% of the value invested. However, if you are already in back-end loaded funds, most companies allow you to switch to other funds at no charge. But it’s particular to each company, so investigate before you switch!
Is their a minimum age for contributing to RRSP's? When is the best time to start thinking long term?
Michael Hlinka: Hi Shruti,
There is not a minimum age.
However for most Canadians, it is most appropriate to think about retirement after entering the workforce full-time. If you start early with a disciplined plan, you can enjoy the present and have lots of money saved for the future.
I would encourage you to consult with Investment Professionals at your local Bank Branch (there’s no fee for a Consultation) and then you can explore your options further.
In light of the volatility in the markets, please summarize in a couple of sentences what segregated funds are, and what the pros and cons would be to holding them in a portfolio. Are Principle Protected Notes the same as segregrated funds or different?
Michael Hlinka: Hi Scott,
Segregated funds are mutual funds with an “insurance component.” This means that, by law, they must be worth at LEAST 75% of the purchase value after a 10 year holding period and at MOST 100% of the purchase value after 10 years.
The problem with segregated funds is that the insurance costs the investor in terms of lower returns — usually about .5% to 1% per year — so you must be aware that you are not getting the insurance for free.
Principal protected notes (PPN) are investment products where the principal is protected and the return is generally linked to a fraction of the return of a risky asset like the stock market. Therefore, a PPN might say that if you invest with us for five years, then at the end you will at least have your principle and 80% of the return of the stock market.
Do you think that Mutual Funds, with their management expenses running as high as 2.5 to 3% in some cases, represent a better investment in a flat or bear market, where professionals can really show their skills, than they do in a bull market where the rising tide tends to life all boats?
Michael Hlinka: Hi Nigel,
The evidence about Mutual Funds is very clear — the vast majority underperform the benchmark after fees and this is true in bear, flat and bull markets. Therefore, I would urge you to consider low-fee Index Funds, with perhaps a portion of your portfolio in actively managed mutual funds if you believe that the particular manager has special abilities.
As a student, I have been advised to hold off on contributing my meagre investment capital to my RRSPs until I determine my employment, and thus, pension opportunities. Is this good advice, or is "something better than nothing"?
Michael Hlinka: Hi Alex,
This is good advice.
You’re only young once and as long as you have a disciplined investment plan once you commence working, you should have nothing to worry about, assuming that you are making a middle-class Canadian wage.
I make a lump sum contribution to my RRSP in February each year. Due to the present market volatility, is it better to use money to make monthly contributions? If yes, over what length of time? I do realise that I will not be able to claim the tax savings this year but I can reduce tax paid at source for these monthly payments.
Michael Hlinka: Hi Naj,
UNDER ALL CIRCUMSTANCES, I strongly recommend monthly contributions which are directed to purchase mutual fund units at regular intervals. Timing the market is a very dangerous game!
What is the best strategy for using up your previous year's(over 10 years) unused contributions?
How do you find out how much is available?
Michael Hlinka: Hi Paul,
You will learn how much is available by looking at the Tax Assessment from the Government. It’s clearly there in the summary.
The “best” strategy would be to contribute to lower yourself to another, lower marginal tax bracket. If you’re making something just over $74,358, get under that benchmark. If you’re making something just over $37,179 get below there. I would not recommend taking out loans to accomplish this because the interest payments are NOT tax-deductible. Just do it gradually over time.
what percentage of USA holdings should be part of the mutual fund portfolio?
Michael Hlinka: Hi John,
First, you should diversify your mutual fund portfolio among the asset classes which means stocks, bonds, and cash. After doing so, most financial advisors would say that you should approximately weight the stock portion as per the weightings of the world’s equity markets, which would mean around 50% US.
However, I think that being Canadian is a “special case” —: and I mean it in this respect. Our markets are very closely linked to the US market, so there isn’t a huge diversification benefit in spreading out between the US and Canada. And if you plan to retire in Canada, putting 50% in the US market exposes you to currency risk, as we’ve seen in the past three years. Which leads me to recommend that Canadian investors under-weight the US equity markets.