So you’ve done the math and decided now is the time to open an RRSP. Good for you. There are all kinds of benefits associated with contributing to an RRSP, not the least of which is a juicy tax return. But, as you may have guessed, the decision-making process doesn’t stop there. It’s time to decide where you’ll open your RRSP, where you’ll draw the funds from and how you’ll invest the money.
RRSP rookies typically wind up at the local branch of their financial institution within days of deadline day. And while there’s nothing wrong with that per say, it’s not necessarily the best approach for everyone.
“Initially, people are attracted by the significant amount of advertising that’s done during RRSP season,” says Harley Lockhart, chair of Advocis, The Financial Advisors Association of Canada.
The first thing RRSP newbies should do is check if their employer manages an RRSP program and whether they offer some kind of top up—aka free money.
“If the employer plan involves any kind of matching from the employer, a person would be unwise not to take advantage of that,” Lockhart says. “That’s an immediate return they can’t replicate.”
Most employers who offer an RRSP program also enable automatic contributions directly from your paycheque, saving you the annual headache come deadline time all while maximizing the benefits of compound interest. You can duplicate the automatic withdrawals on your own however if you’re not happy with the investment options available through your employer’s plan sponsor.
“The difficulty with many employer plans is that there is no advice,” Lockhart says. There’s also a good chance you’ll have to do some additional paperwork and pay a small fee if you decide to transfer your RRSP holdings if and when you change jobs.
Next you’ll have to decide how to invest your RRSP. Remember an RRSP is not an investment in and of itself, it’s simply a storage container for other investments with certain tax-saving characteristics.
You have to know your risk tolerance in order to make sound investment decisions, says Lockhart. Those approaching retirement should hold safer investments than young professionals with lots of time to recover from steep portfolio drops. Talk to a professional or take a self-evaluation to get a general sense of your tolerance level.
Once you’ve establish your risk tolerance, brush up the RRSP investments options available to you. “Someone who is just starting out has to extra due diligence,” Lockhart says. That’s because they typically have less money to invest so access to top-tier advice can be a challenge, especially at large institutions.
At a very minimum, first-time RRSP contributors should research active and passive investment strategies.
“If they do their research in those two areas, they are covering their bases,” Lockhart says.
For his own clients, Lockhart recommends a mix of investments that offer safety, income and opportunity for growth.
Once you’ve decided how to invest your money, it’s time to shop around for the best rates. You’ll want to check with discount brokerages, mutual fund companies and more traditional financial institutions. Investor Education Fund lists the types of fees you might run into.
Lockhart suggests kick-starting your RRSP with the money from your TFSA, if you have one. First-time contributors generally have large amounts of unused RRSP contribution. Find out what your RRSP deduction limit is and how much unused contribution room you’ve accumulated here. Your approximate RRSP-generated tax refund can be calculated here.
Once you’ve opened your RRSP continue to contribute to the TFSA, says Lockhart.
“I believe that it is possible to put too much money into an RRSP. I don’t believe that everybody should just maximize their contribution every year just because they can (unless they have incomes in the top marginal tax bracket).”
“If you are only paying 30% in tax, I question the value of the (RRSP-related) tax deduction at all.” In those cases it would be better to be in a TFSA since it’s more flexible and you’ll never pay tax on the gains.
Most people aren’t thinking about their annual RRSP contribution as an investment, says Lockhart. They are thinking about it as a tax break.
“The tax break is a factor, but it should not be the only factor and the weight given to it is unwarranted.”