The Really Simple Guide to RRSPs

This is the time of year when we start to see full blitz media campaigns from banks and financial planners urging Canadians to contribute to their registered retirement savings plans (RRSPs). Unfortunately, they don’t tend to do a great job of explaining what RRSPs are or why you should consider them, beyond veiled references to having to eat cat food in retirement. To better help you make a decision, here’s my really simple guide to RRSPs:

1. An RRSP is the basket, not the fruit. An RRSP isn’t something you can buy, it’s a place to keep the things you do buy. You can fill your RRSP basket with all sorts of investments, like GICs, stocks, bonds, exchange traded funds (ETFs), or you can even just keep cash in there to earn interest. When most people say they are going to buy some RRSPs, they actually mean they’re going to buy mutual funds within an RRSP. Mutual funds are probably the most popular RRSP investment, but they’re also usually a suckers bet and tend to benefit financial planners more than investors. Don’t invest in mutual funds- you’re smarter than that.
2. RRSPs are good because they (might) save you tax dollars. Why are RRSPs such a big deal? Because they can save you money at tax time. Every dollar you invest in an RRSP is a dollar that can be deducted off your income at tax time. This could result in having to pay in less taxes, or even getting a nice, chunky refund. How much you save will depend on your marginal tax rate . If you’re in a lower tax bracket this could be as little as 20%; if you’re in a higher tax bracket, it could save you up to 50%, depending on your province. But RRSPs aren’t tax free- they’re tax deferred, meaning that you’ll have to pay taxes on your RRSPs when you go to withdraw the money. The general idea is that when you’re retired you’ll be in a lower tax bracket than when you bought.
3. You can invest in an RRSP at any time. RRSPs get a lot of attention this time of year because you can include investments made before March towards last year’s (2008) taxes. But don’t be fooled- you can invest at any time, and there’s generally nothing available in February that’s not available any other time of year, besides high-pressure sales tactics.
4. RRSPs are not just for retirement. Despite the first “R” in the title, RRSPs (or, more accurately, RSPs) can be used for things other than retirement. First-time homebuyers can withdraw up to $25,000 from their RRSPs towards the purchase of a house without any tax consequences through the Homebuyers Plan (HBP), although the amount needs to be repaid within 15 years. Similarly, under the Lifelong Learning Plan (LLP), you can withdraw up to $10,000 per year without being taxed to pay for education if you decide to go back to school. You can also generally cash out your RRSPs at any time for any reason, although you’ll be taxed on the amount you withdraw and lose that contribution room forever.
5. RRSPs aren’t always the answer. RRSPs are good, but they’re not for everybody. If you expect to be in a high tax bracket when you retire (for example, if you’ve got a sweet pension), your actual savings could be minimal. Similarly, if you’re currently in a low tax bracket the tax savings that you’ll realize may not be worth it. You need to save for the future, but you also need to decide if RRSPs are the best way to do that.

And there you have it! You now know enough about what RRSPs are and how they work to make an informed decision and to figure out what works best for you. You’re welcome.

For my American readers, my guide to RRSPs is even simpler: it’s like a 401(k), but a little different.

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