As the deadline nears for 2014 contributions to RRSPs, you may be tempted to simply add money to your account and buy a guaranteed investment certificate.
That would be a good thing. As interest-bearing securities, GICs and bonds are ideally suited for the tax deferral offered by registered retirement savings plans because interest income earned outside a plan is taxed at your highest marginal rate.
Your RRSP account may comprise your entire investment portfolio. Or you might use it in addition to a tax-free savings account and a non-registered account with a discount broker or investment dealer.
If you fit the latter description, remember to step back and look at where your RRSP fits into your larger portfolio. How should it best be used?
"People tend to look at the asset mix account by account," says Matthew Ardrey, manager of financial planning at T.E. Wealth in Toronto, "but they should look at it on a total portfolio basis instead."
Marc Henein, a fee-only investment adviser at ScotiaMcLeod, agrees.
"If you look at each individual account, you will mismanage the money," Mr. Henein says. Too much risk in one account, or overconcentration in another, "will sabotage your asset allocation," he says. "Asset allocation drives 90 per cent of your investment return, so if it is off, the whole portfolio return will be off."
If your RRSP is your sole retirement tool, you might want to hold securities inside it. Ideally, however, you can fill your RRSP with interest-bearing securities while holding stocks and stock funds in your taxable account, where they will benefit from preferred tax treatment on dividends and capital gains, advisers say. Once your RRSP is full, you can add some interest-bearing securities to your tax-free savings account.
The beauty of RRSPs, if you open one when you are young, is the decades of tax-deferred compounding, Mr. Ardrey says. "Even at 72 [when you must convert your RRSP to a registered retirement income fund and begin withdrawing money], you only have to take 7.4 per cent out, so the tax-deferred compounding continues," he says. "It makes a big difference in a higher tax bracket."
You also have to look ahead to the tax bracket you might find yourself in after you've retired, advisers say.
"You can have too much money in an RRSP," says Jason Pereira, a financial planner at Bennett March/IPC in Toronto. There may come a time when you should stop contributing to avoid paying higher taxes later.
"You have to look at your lifetime tax bill," he says. No point getting a 40-per-cent tax break now and paying closer to 50 per cent later. In this case, you can tuck the money into your TFSA instead.
Some planners also include defined-benefit pension plans in the "whole portfolio" calculation, arguing that people with pension plans can hold more of their portfolios in stocks because the pension serves as their fixed-income allocation.
"There are two schools of thought," Mr. Ardrey says. He's skeptical of those who argue you can hold mostly stocks in your portfolio because of a pension plan.
"Most of my clients' risk tolerance doesn't change just because they have a defined-benefit plan," he says. "Most of them went through the 2008 crash. You don't feel any less sick to your stomach watching your equities drop just because you have a defined benefit pension plan." Holding bonds buffers the drop, he points out.
You could argue that a pure stock portfolio across all accounts will give you a better rate of return over time than if you balanced it with fixed income, he acknowledges. But that has its pitfalls.
"Try to keep someone invested in a portfolio like that when the world seems to be falling to pieces," Mr. Ardrey says. Too often, investors panic and sell.
The makeup of your portfolio – RRSP included – will change with age, advisers point out. Take the RRSP: First it's designed to accumulate wealth, then to provide a steady income.
Bonds are more suited to RRSPs than stocks on two counts, Mr. Pereira says. The interest income is sheltered and tax is deferred, and the growth over time will be slower than with stocks, so you will have a lower tax liability when you begin withdrawing money. In other words, a smaller RRSP can be good.
An RRSP is the worst place possible for a speculative stock because whatever big gains you hope to make will be fully taxable when you take the money out, he says. "The RRSP is the worst place for high-growth assets." High-growth stocks might make good sense in a TFSA, where the gains are sheltered and no tax is paid when the money is withdrawn.
Once you begin collecting Old Age Security, the picture changes, Mr. Pereira says. If you are near the income threshold where your OAS benefits start being clawed back ($71,592), it's preferable to receive interest income rather than dividends. That's because the Canada Revenue Agency "grosses up" the dividend income when calculating your total income, he says.
(Grossing up is complicated, but in a nutshell, the CRA adds back the income tax the dividend-distributing corporation would have paid before its issue. The dividend tax credit is then applied to this higher amount when calculating how much tax a person owes.)
So you'd do the opposite of what you had done while you were working, shifting dividend-paying stocks to your RRSP/RRIF and bonds and non-dividend-paying stocks to your taxable account.
He offers this example: The 2014 dividend gross-up rate (the estimated corporate income tax paid) is 38 per cent. If you earn $10,000 in dividends, the CRA grosses the number up to $13,800, which could be enough to put you offside with the clawback, Mr. Pereira says.
If you exceed the clawback threshold, you will begin paying back your OAS benefits at the rate of 15 cents on the dollar. So if you had $81,592 in income, you would pay back $1,500. "The OAS clawback is really a tax, so you want to keep yourself below that threshold."