Editor's note: This week on Morningstar.ca, we present our Focus on RRSPs, where we go over what every investor needs to know about Canada's most popular savings program. Along with an explanation of RRSP basics, we will look at important issues such as whether it makes sense to defer savings, the life-cycle approach to retirement contributions, and ways to go beyond the traditional RRSP. Finally, our manager research analysts will present their favourite funds to hold in a retirement account. Check back all week for more insights from Morningstar's experts.
There's much more to getting the most out of your RRSP than going to a bank branch and putting your contribution into a cash deposit. For many investors, a self-directed plan is the way to go, since it allows one to hold many different types of investments. By doing so, you'll have more opportunities to improve your risk-adjusted returns and achieve your long-term goals.
What's more, if you are married or living common-law, you should consider the advantages of one spouse contributing to the other's RRSP, with the goal of producing equal streams of income after retirement -- and thus minimizing the amount of tax you must pay on your combined incomes.
Self-directed plans
Unlike cash deposits and some proprietary mutual funds such as those sponsored by banks, everything else must be held within a self-directed plan. This is basically a trust account in which you can keep your RRSP holdings in one place, and have access to a full range of investments.
There is a cost to this, in the form of an annual trustee fee, which typically is $100 to $150, although usually considerably less if you have an account with a discount broker. Also, fees are commonly waived for accounts that exceed a specific dollar amount. Robo-advisors may charge a small fee based on the account's assets under management.
Note that all RRSP-related fees, including management and transaction charges, are not tax-deductible. Generally speaking, a self-directed plan makes financial sense for an RRSP worth $25,000 or more.
The following Canadian-based investments are eligible for a self-directed RRSP:
- Cash (savings accounts, term deposits, GICs, Canada or provincial savings bonds, government treasury bills);
- Bonds or debentures (issued by federal, provincial or municipal governments, or by publicly listed corporations), as well as certain other investment-grade debt instruments;
- Government-insured mortgages (subject to restrictions);
- Shares issued by corporations listed on a Canadian stock exchange;
- Other securities, such as stock options, listed on a designated exchange (futures contracts are not eligible);
- Mutual funds and segregated funds (that meet RRSP eligibility rules);
- Gold and silver bullion;
- Certain small-business shares.
For many years now, there has been no foreign-content restriction for RRSPs, which means theoretically an entire portfolio can be non-Canadian. These foreign holdings may be in the form of Canadian-domiciled mutual funds that invest outside Canada, such as U.S. equity, international equity and emerging-markets equity funds. However, the list of RRSP-eligible direct holdings of foreign securities is limited, mostly to shares listed on specified stock exchanges and bonds issued by some foreign governments.
You can make a contribution in kind to a self-directed RRSP by transferring an investment from a non-registered account. This would be done at the shares' market value. Note, however, that you would trigger a capital gain, because as a trust a self-directed RRSP account is considered a separate entity. Also, you cannot claim a capital loss when making a contribution in kind. You could, however, sell the shares you want to transfer on the market, contribute the proceeds in cash and then repurchase the shares 30 days or more later (thus staying onside with the anti-avoidance rules).
Spousal RRSPs
The basic concept of investing though an RRSP is to maximize your returns over time, due to tax-deferred compounding over the long term, and the potential of paying tax at a lower rate on those savings after retirement than you would have paid on that money while you were working.
By allocating part or all of your RRSP contribution to your lower-income spouse's account, you can create two equal streams of retirement income. In theory, this will result in a lower combined income-tax bill when the money is withdrawn through a registered retirement income fund (RRIF) or a registered annuity.
A spousal RRSP enables one spouse to contribute to the other's plan, and claim the related deduction on his or her own tax return. Your contributions to a spousal RRSP do not affect your spouse's own RRSP contribution room. He or she can contribute each year to his or her maximum limit as well. As a result, the contributor gains a valuable tax deduction, and the recipient can build his or her own RRSP savings.
Spousal RRSPs and other effective income-splitting strategies also may help eliminate or reduce the amount of Old Age Security income that is clawed back. At present, anyone with income in excess of approximately $73,800 must repay at least some of his or her OAS benefits. Above that threshold, the greater your income, the greater the clawback will be. At nearly $120,000, all of your OAS must be returned to the government.
If you are older than your spouse, you may continue making tax-deductible contributions to a spousal RRSP after the year in which you turn 71, the normal deadline for collapsing an RRSP. You can keep on making spousal contributions until the end of the year in which the recipient spouse turns 71.
Money contributed to a spousal RRSP is subject to a three-year attribution rule. This prevents the higher-income spouse from contributing and then withdrawing the funds soon after at the spouse's lower income-tax rate. If a contribution is withdrawn from a spousal RRSP during the calendar year that the contribution was made -- or in the two preceding calendar years -- the contributing spouse would have to pay tax on the amount withdrawn.
In the event of divorce or marriage breakdown, regardless of any spousal-RRSP contributions, all pension assets accumulated between the spouses would be combined and split equally, according to provincial family law.
Assuming marital harmony, however, spousal RRSPs along with the investment flexibility of self-directed plans can provide a foundation for a comfortable retirement.
