Full Disclosure Finance

By Justin 

If you’re thinking RRSP is some new acronym, you definitely need to read on. Even if you know what it is you could likely use a refresher on the fundamentals.

A Registered Retirement Savings Plan is a vehicle setup by the government (Canada Revenue Agency) that allows Canadians to defer taxes on amounts earned inside it until you begin earning RRSP retirement income. All money contributed to an RRSP can be used as a deduction from your earned income, meaning you’ll pay less income tax by contributing. Think of an RRSP as a box with special rules governing all investments held inside.

You can setup an account with any major financial institution, credit union, or investment service provider. Grant Thornton LLP’s Smart Tax Tips recommends that you get a self directed plan because it is the most flexible for control and tax planning strategies.

The maximum amount you can contribute while still being able to deduct it from your taxable income is equal to 18% of your earned income up to a maximum of $20000 for 2008. If you are a member of a Registered Pension Plan or Deferred Profit Sharing Plan the rules are different so consult your company advisor. Earned income includes the following: Salaries, profit sharing income, business income, and rental income. It also is reduced by business losses, rental losses, and employment expenses. It should be noted that investment income, capital gains, and business income earned as a limited partner are not classified as earned income.

Your RRSP contribution limit will also appear on your Canada Revenue Agency Notice of Assessment. This represents the amount in addition to your contribution limit for the current tax year (18% of earned income) that you could put into your RRSP and receive the tax benefits.

As an example: If your Contribution Limit from your 2007 Notice of Assessment says $10,000, this means you can contribute a total of $10,000 + 18% of your earned income.

Why contribute to an RRSP?
1) Present Tax Savings: Your contribution is tax deductible – which results in greater savings for those in higher tax brackets
2) Future Tax Savings: Income / Gains generated are only taxed on withdrawal
3) Income Splitting: All or a portion of your contribution can be made to a spouse or common law partner’s RRSP.

If you are an employee and have no other possible deductions or tax credits, it is critical to contribute to an RRSP if you want to pay less tax.

We’ve covered the principles behind putting money into your RRSP. What about taking money out?

Why keep your money in an RRSP once you’ve contributed?
According to Fidelity, any money taken out will be subject to a withholding tax ranging from 10-30%. The amount you pull out will also be added to your taxable income for that year.

Note that contributing to an RRSP will serve to increase the equity you have. In terms of cash flow, it actually decreases the amount of cash that is readily usable or liquid because you are adding money into “the box”. Taking money out is not worthwhile, it is better to not contribute in the first place. Your cash flow will increase at year end because an RRSP reduces your taxes owed, resulting in a larger refund or smaller tax payment. However, the cash you put away throughout the year will yield its savings in the following April. You may need to use this cash before April, thereby reducing this advantage.

Depending on your investments of interest, the cash flow impact may not be an issue.

What investments can be held inside an RRSP?

In your RRSP you can hold many types of investment. This list is from accounting firm BDO:
Cash
GIC’s
Government Debt and Corporate Debt listed on Canadian Stock Exchanges
Shares or units in Canadian based mutual funds certified RRSP eligible by the Canada Revenue Agency (I suspect Mr. Hedge Fund got left out of the party)
Options on the purchase of qualified investments (puts and calls baby!)
Shares of any Canadian public corporation
Shares listed on the TSX-V, TSX, and MX
Shares listed on most foreign stock exchanges

There are some quirks I would like to talk to my accountant about. For example, if I were to invest in a privately held Canadian company which proceeded to go public, how would it be treated by the CRA? The status of my investment would have moved from non-qualified to qualified.

 How much will one save by contributing to an RRSP vs. a regular investment account.  I’ve never seen anyone actually quantify the benefits.  I will seek to do that over the next few weeks and let you know the results.

Anyways, we’ll save the special situations for another day. I hope I’ve provided the RRSP basics for you. Now get out there, open up your self directed RRSP account, and start buying!