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woman with head in her hands nearing retirement


According to a recent poll conducted by TD Waterhouse, 61 per cent of baby boomers say they will use RRSPs to help fund their retirement plans. Surprisingly, that was slightly higher than the number who cited CPP/OAS as an important factor in their planning. If RRSPs are that central to the financial mix, it stands to reason that we had better get them right. So to end this chapter, I have compiled a list of RRSP dos and don'ts that sum up the main points I want to leave you with.

1. Don't ask friends for advice.

There are a lot of misconceptions about RRSPs out there, so don't assume that what someone tells you over lunch is necessarily right. Go to a reliable source. There are numerous books on the subject, as well as magazine and newspaper articles. The Canada Revenue Agency has a page that is a useful gateway to a wealth of RRSP information, and a Google search will turn up many more references.

2. Do choose the right plan.

I have not seen any precise numbers, but it's a safe bet that billions of dollars of RRSP money is tied up in guaranteed investment certificates. The banks love GICs and promote them aggressively. Why not? They get to use your money for many years (five-year maturities are standard), loaning it out to others at higher rates and making a nice profit in the process. Meantime, your RRSP grows at a snail's pace. My advice is to open a self-directed RRSP that gives you the maximum possible investment flexibility. Yes, it will cost you – the annual fee will probably be in the $100 to $150 range. But you should more than make up for that with much higher long-term returns. As mentioned earlier, an average annual gain of between 5 per cent and 6 per cent, which is realistic in a conservatively managed plan, will keep you ahead of inflation and build genuine value in your RRSP.

3. Don't speculate.

Never forget that your RRSP is just a mini pension plan. That means you must think like a pension fund manager – protecting capital, avoiding unnecessary risk, and aiming for a reasonable return on investment. While all investments carry some degree of risk, there's a wide chasm between prudent risk and speculation. Your RRSP is not the place to gamble. Keep it conservative, even dull.

4. Do contribute regularly.

I know you've heard this a million times. Well, now it's a million and one. The easiest, most painless way to build an RRSP is to have automatic contributions deducted from your account each month. People who wait until RRSP season comes around often end up without any money to invest. They vow to do it next year but usually don't.

5. Don't blow the refund.

The tax refund generated by an RRSP contribution is windfall money. It's like winning the lottery – it is all yours to keep, with no tax to pay on it. Depending on how much you contributed, we could be talking about thousands of dollars. The temptation, especially with younger people, is to spend it. I can suggest several better ideas that will build your personal wealth in the process. Pay down credit card debt. Pay down the mortgage. Contribute it to a TFSA. Put it back into the RRSP as the first contribution for the next tax year. Add it to your non-registered investment account. Just don't blow it!

6. Do borrow, but carefully.

If an RRSP loan is paid off quickly, preferably within a year, the math is compellingly in favour of going that route if the cash for a contribution is not immediately available. Let's look at the case of someone who has a 35 per cent marginal tax rate and needs $5,000 to make an RRSP contribution. We'll assume interest of 4 per cent on the loan. Using our assumptions, a $5,000 loan will generate a tax refund of $1,750. If the invested money earns 5 per cent this year, the RRSP will grow by $250 in 12 months. The total gain (investment income plus tax savings) is $2,000, which is a 40 per cent return on investment. If the loan is repaid over 12 months at a rate of $425.75 per month (principal and interest), the total interest expense will be only $108.99. That can be reduced further by applying the tax refund against the loan principal. In sum, it has cost slightly more than $100 to generate a cash benefit in the first year of $2,000. And the invested $5,000 keeps on giving. With an average annual compound rate of return of 5 per cent, it will grow to almost $17,000 over twenty-five years. So by all means, borrow for an RRSP as long as the loan can be repaid within a year, or two at the most. But avoid getting locked in to a long-term loan, even if the interest rate is attractive. The returns diminish for each year that you are paying it off, especially since the interest is not tax-deductible.

7. Don't contribute if you expect your income to be low.

RRSPs are great savings vehicles, but they aren't right for everyone. In particular, older people who expect to have low incomes after retirement should avoid them. Any money available for savings should be put into a TFSA instead. This is because RRSP/RRIF withdrawals are taxable income and will affect your eligibility for income-tested government benefits and tax credits, including the Guaranteed Income Supplement (you lose fifty cents for every dollar in income over $3,500), the GST tax credit, and the age credit. TFSA withdrawals, on the other hand, are not considered income for any of these calculations.

8. Do pay off high-interest loans first.

I have always regarded RRSPs as one of the pillars of wealth building, but that doesn't mean they should always take top priority. Anyone carrying high-interest, non-deductible debt, such as a credit card balance, should pay that off first before even considering an RRSP contribution. And finally, do open an RRSP and contribute to it regularly. In future years, you'll be happy you did.

Excerpted from: Retirement's Harsh New Realities by Gordon Pape. Copyright © Gordon Pape Enterprises Ltd,. 2012. Reprinted with permission from Penguin Group (Canada), a Division of Pearson Canada Inc.