Tuesday 23 February 2010

It's time to think about RRSPs

Some people love number crunching and abstract intangible financial things with such acronyms as GIC and CCA.

Other people are not particularly interested in having anything to do with them.

For those who classify themselves among the latter group, it is still wise be open-minded towards some of those intangibles, especially the ones known as Registered Retirement Savings Plans.

The RRSP is a tax-free financial plan, registered with the federal government. Its existence is to enable us to save money more easily for our eventual retirement through contributions to the plan. The plan is not a specific type of investment. It's a method of holding various types of qualifying investments that include stocks, mutual funds, bonds, guaranteed investment certificates, and others.

"People are allowed to make contributions on a yearly basis through various registered organizations or on a self-directed basis", says Ernest J. Boudreau, a partner in the Moncton accounting firm Boudreau Porter H├ętu.

"The contributions are made based on the level of income (the contributors) earned the year before," he says.

The maximum contribution for 2009 is 18 per cent of the previous year's income, to a maximum of $21,000.

According to Boudreau, "The contributions that are made are tax-free. So, in other words, when you make a contribution, you're allowed to deduct this contribution from your income on a year-to-year basis. You're able to defer the tax until you retire and then you withdraw the tax from there. You pay taxes at that time."

The maximum amount for contributions will rise to $22,000 for 2010.

"The reason that the government puts a cap on (the annual contributions) is that that sort of income, that amount of money that you're putting into your RRSP is not taxable," Boudreau says. "The government is not receiving the tax on that money. They don't want people to put any extra than that amount of money because they would be losing that tax revenue."

In most cases, people invest in RRSPs at regular intervals with a periodically fluctuating interest added to the principal. As such, the investment is a compound-interest annuity.

Something important to think about when planning to retire, regardless of when or how far into the future retirement might be, is how much money you want to have. Once that is determined, it will be easier for you to decide on where and what to invest into RRSPs.

As an example, let's say that Mr. Investor would like to have an RRSP worth $2,000,000 when he retires at age 65. Today is his 30th birthday, which means that his 65th is 420 months away. He's thinking of entering into an investment that pays 15 per cent interest. With all of that information, he or his financial advisor can calculate how much money he needs to invest per month in order to reach his goal.

This basic formula is useful in helping to filter through the different investment options available to investors.

"Either you're contributing to an RRSP that's being administered by someone, a bank, a trust, or qualified professionals or insurance company, to whom you pay a fee," Boudreau says, "or there's a self-directed RRSP. In other words, you decide; you direct the RRSP plan yourself. You decide where you want the money to be invested in the stock market, mutual funds, or interest directed by yourself without the help of a third party.

"As amounts grow in your self-directed RRSP, it could be useful to seek the help of professionals who have tools to research various investment markets; this could increase your potential returns on investments."

Like with anything else, Boudreau says that investors can mishandle things and make common mistakes.

"(If) you invest in something (and) you lose the money that's in your RRSP, certainly you're out the money. So, the mistake is not being able to manage the money correctly and efficiently to get a good rate of return."

As the population lives longer, many of past social norms are changing. One of those changes is the fact that many people are working past the traditional retirement age of 65.

You cannot, however, buy RRSPs past the age of 71. People who have reached that age must also remove or transfer what they have previously invested.

"At 71, you have to transfer your RRSPs to a registered retirement income fund (RRIF), annuities, or start taking them out in an orderly fashion, so that, essentially, you use the money for your retirement rather than keep deferring it over certain years," Boudreau explains.

"The government is probably worried about the fact that, when people arrive at these types of ages, that they probably need that money and that they shouldn't be worrying about being on social assistance and things of that nature. Certainly (the government) would be looking to the fact that the taxes were deferred and that now's the time when you need the money. You should be using it in an orderly fashion."

To maximize future benefits of RRSPs, Boudreau suggests the following: "Over-contribute up to $2,000 in any one year to the RRSP and that amount of money will keep growing in your plan without having the deduction for it. However, the income on that extra $2,000 will not be taxed and it will make your retirement plan even higher."

Basically, the earlier people contribute to RRSPs, the better it will be for them.

Boudreau offers some final words of caution:

"It's always good to have a balanced approach to finances and to make sure that you don't build-up too many debts in other areas so that you can constructively contribute to RRSPs."

* Bernard C. Cormier is, among other things, a freelance writer and broadcaster. www.myspace.com/bernardccormier. www.twitter.com/bernardccormier. E-mail: Bernardccormier-gncb@hotmail.com, © Bernard C. Cormier 2010