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RRSP Season

What to do with your money in a volatile market Add to ...

With stock markets moving in tandem with a Drop Zone amusement park ride, and interest-bearing products paying next to nothing, many investors are wondering what to do with their RRSP investments this year – or even whether to make one.

“People are panicked,” says certified financial planner Sharon Rizzuto of Burgeonvest Bick Securities Ltd. in Grimsby, Ont. “If you gave them a risk profile before and gave it to them now, it would be entirely different.”

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One of the reasons to make an RRSP contribution despite the uncertain investment conditions is the tax savings it affords, and that’s why Ms. Rizzuto advises doing so, especially if you don’t have a company pension plan.

RRSP contributions are deducted from your taxable income, so you’ll get a refund when you file your income tax. Ideally, you will use that refund to pay down debts such as a mortgage.

Investments held inside an RRSP grow free of tax. When you retire, most people’s incomes will be less than when they were working, meaning you can withdraw money at a lower tax rate than when you contributed and receive a refund.

To maximize the tax benefits, people have traditionally been advised to hold interest-bearing products, such as guaranteed investment certificates (GICs), inside an RRSP where the interest can compound tax-free, and to keep investments that incur capital gains, such as stocks, outside an RRSP, because capital gains and dividend income are already taxed at the lowest rate. But with GICs earning historically low interest rates now, conventional wisdom may not hold.

“Now maybe it’s the capital gains you want to shelter because it looks like that’s where the gains are going to be,” Ms. Rizzuto says.

But the stock market’s extreme volatility may have frightened many investors away completely. People who poured everything into mutual funds a few years ago are retrenching, putting whatever they do invest into “risk-free” products such as GICs.

“They think that at least they’re protecting their capital,” Ms. Rizzuto says. However, investing $1,000 in a one-year GIC will earn only about 1.5 per cent at the moment. By the time you pay registration and adviser fees you’re not earning anything and likely cutting into that capital, she notes.

Consider your time horizon – how long do you have before you need to draw on your RRSP funds – when determining what to do.

Many people make RRSP contributions with the idea that they can use the money down the road as part of a down payment on a home. The Home Buyers’ Plan (HBP) allows you to withdraw up to $25,000 in a calendar year from your RRSP to buy or build a house or condo. The HBP stipulates that your RRSP contributions must remain in the RRSP for at least 90 days before you can withdraw them, and generally you have 15 years to put what you withdraw from your RRSP back into it.

For these people, and others with a short time horizon, a fixed-income product such as a GIC is likely best, Ms. Rizzuto says. But if you are a young person saving specifically for retirement, she recommends going for capital gains and toughing out the market for the long term.

If you’re looking at putting RRSP funds into stocks for long-term gains, go back to basics, Ms. Rizzuto says. “We need to get back to the business of looking for individual companies, quality companies. … If you choose a business to invest in, do your homework to be careful that it’s a good business. Eventually it will come around, but you need patience.”

The people facing the most difficult investment decisions are those in their 50s, who have only 10 or 15 years to go before retiring. “This is a tough one because they need that good bump [financially]that equity markets can give. The problem is they can’t take the downside, but really need the upside,” she said.

Last year she put people in this situation into three-year, fixed-income products, and high-yield bonds. She also likes to find products that do “asset allocation in a strategic way,” putting specific percentages of holdings into fixed income, equities, bonds, cash and so on. Each time the percentage of one of those holdings changes, the excess is sold and the assets are rebalanced to meet the preset proportions.

There is also a school of thought that this might be the year to take a pass on RRSP contributions altogether and focus on paying off debts, especially credit cards. The Canadian Imperial Bank of Commerce recently released a report saying that a growing proportion of Canadians older than 45 are among the country’s highest debtors.

Financial advisers always recommend making a full RRSP contribution and using the tax refund it generates to pay down debts. But Hamilton, Ont., credit councillor Barb Stirling says it takes a very disciplined person to do this. “Most people can’t help using a tax refund to go on a winter holiday or put new brakes on the car.”

If you’re indebted due to a job loss or illness, get your current finances in order. The downside of not contributing to an RRSP is you’ll be foregoing a year of tax-sheltered growth and, if the market picks up, your nest egg won’t profit from it, she says.

However, as The Globe’s Rob Carrick pointed out in a recent column, there is a real risk that too much money is being directed into debt payments at the expense of retirement savings. He cited a Statistics Canada report that almost 93 per cent of tax filers were eligible to contribute to an RRSP for the 2010 tax year but only 26 per cent actually did so.

Ms. Stirling agrees that’s a concern and urges anyone focusing on paying off debts over making RSSP contributions this year to work saving for retirement back into their budget as soon as possible. “It won’t be fun, but you’re probably going to have to cut back spending on other things.”

Special to The Globe and Mail

For tips, stories, videos and live chats ahead of this year's RRSP contribution deadline, check the Globe Investor 2012 RRSP season website for daily updates.

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