Tag: RRSP

It’s RRSP and TFSA season again

Registered retirement savings plans (RRSPs) and tax-free savings accounts (TFSAs) are always topical at the beginning of the year. And, for anyone considering these options, there are two primary considerations right now: what new available contribution room you may have for your TFSA, and that you have the first 60 days of the year to make an RRSP contribution against your previous year’s income.

To help you understand the differences between the two tax-sheltered investment vehicles, we put together a general FAQ. However, before going over the mechanics, we want to stress how important it is to use these programs in your financial plan. There is almost no circumstance where it would make sense to hold investments that generate growth or income in a non-registered account rather than in a TFSA.

As an example of the power of the RRSP, we ran some numbers to consider. This is based on a high-income earner, age 30, and compares saving within an RRSP and investing the resulting tax savings as well, for 41 years, until age 71, and then cashing it all in and paying tax thereon, versus simply saving in a non-registered account.

In the example, the individual invested $24,000 per year in a portfolio that generated an income of 5% per year. We used a tax rate of 50%. At age 71, the after-tax cash savings in the hands of the individual, having used the RRSP program, is $808,000 greater than the traditional non-registered plan.

As you can see, the advantage of the RRSP is extremely significant and cannot be overstated.

TFSA basics

The tax-free savings account program began in 2009 to provide Canadians with an account to contribute and invest money tax-free throughout their lifetime. Contributions to a TFSA are not deductible for income tax purposes. Any amount contributed, as well as any income earned in the account (investment income and capital gains) are tax-free, even when it is withdrawn.

The allowable contribution room for a TFSA has changed over the years, and can be seen in Table 1.

TFSA has many important features:

  • to have one, you must be 18 years of age or older with a valid social insurance number,
  • there is a tax-free accumulation of income and gains,
  • you have tax-free withdrawals – at any time, for any reason,
  • they have no impact on income-tested benefits such as child tax benefits and guaranteed income supplement,
  • you can invest in any RRSP-qualified investment, such as mutual funds, ETFs, stocks, GICs, etc.,
  • the interest on money borrowed to contribute is not tax-deductible,
  • no attribution rules apply – it’s good for income splitting between spouses and can be transferred to the surviving spouse’s TFSA if they are the designated beneficiary,
  • to avoid penalties, you must be careful to not over-contribute, and
  • you can recontribute amounts withdrawn in previous years, and there is a 1% penalty per month if recontributed in the same calendar year.

RRSP basics

The registered retirement savings plan program was introduced by the Canadian government in 1957 to help Canadians save for retirement. All income accumulates on a tax-deferred basis and contributions are deducted against your taxable income in that particular tax year. As of 2020, the RRSP deduction limit is 18% of your earned income, to a maximum of $27,230. You should always check this amount with your accountant and/or CRA.

The important features of an RRSP include the contribution period, which is from Jan. 1 to the 60th day of the following year, and that the maximum age to contribute is 71. There is no minimum age for contributing, but, starting in the year after the year you turn 71, you must start making specified annual withdrawals from your RRSP, which now becomes a registered retirement income fund (RRIF).

The Home Buyers’ Plan (HBP) allows you to withdraw from your RRSP to buy or build your first home. In this case, the money must be in the RRSP for 90 days before withdrawal is permitted, and you can withdraw up to $35,000. Regarding repayment of the withdrawal, participants must repay 1/15th per year (starting in year 2), with the total amount paid off in 15 years.

The Lifelong Learning Plan (LLP) allows you to withdraw funds from your RRSP to finance full-time training or education expenses for you or your spouse or common-law partner. You can participate in the LLP for yourself, while your spouse or common-law partner participates in the LLP for him or herself; you can both participate in the LLP for either of you; or you can participate in the LLP for each other. Withdrawals of up to $10,000 in a calendar year and up to total of $20,000 are permitted, and participants must repay 1/10th of the amount withdrawn per year, with the total amount paid off in 10 years.

Philip Levinson, CPA, CA, and Brent Davis are associates at ZLC Financial, a boutique financial services firm that has served the Vancouver community for more than 70 years. Each individual’s needs are unique and warrant a customized solution. Should you have any questions about the information in this article, visit zlc.net or call 604-688-7208.

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Disclaimer: This information is not to be construed as investment, legal, taxation or account advice, nor as an offer to sell or the solicitation of an offer to buy any securities. It is designed only to educate and inform you of strategies and products currently available. The views expressed in this commentary are those of the authors alone and are not necessarily those of ZLC Financial or Monarch Wealth Corp. As each situation is different, please seek advice based on your specific circumstance.

Better ways to invest RRSPs

This RRSP season, you can give your portfolio a gift – the potential for better returns and reduced risk. (photo from 401kcalculator.org via Wikimedia Commons)

Many RRSP portfolios struggled in 2015 to produce returns sufficient for the goals of retirement building and wealth preservation. An over-reliance on equities, and particularly Canadian equities, left many RRSPs in negative territory and, so far in 2016, the stock market has continued to erode savings. But, this RRSP season, you can give your portfolio a gift – the potential for better returns and reduced risk.

The concept of what we call a registered retirement savings plan (RRSP) was introduced by the federal government in 1957 to encourage Canadians to save for their retirement. Although the rules have changed over the years, the basic benefits are every bit as valuable today as they were at inception: the ability to contribute pre-tax dollars and thereby reduce income for taxation, and the ability to compound gains within an RRSP while deferring taxes on the gains.

Many of us are good about setting up our RRSPs when we’re young, and dutifully contribute the maximum allowable each year. Typically, our RRSP accounts start out as just another brokerage account with an emphasis on long-only stock investing. But, by the time we reach our 40s, those RRSP dollars can start to add up. For top-earning Canadians contributing the maximum allowable, an RRSP account can hit $500,000 by middle age and keep going from there.

In addition, our risk tolerance changes as we age and our runway of remaining working years shortens. Conventional wisdom is that longer-term investment vehicles like RRSPs can take on more risk, as greater volatility over the long term often yields greater return. Unfortunately, this notion fails to anticipate how long it can take to overcome the drag of a negative year, and the fact that when a major loss occurs late in a life, there may not be enough time for wealth to catch up to needs. Consider, for instance, the unfortunate plight of anyone who had to rely on their RRSP in late 2008, before the Federal Reserve and its counterparts stepped in and refloated stock markets.

The collapse of stock markets in 2008 and 2009 prompted many to take their RRSP money out of the market and rethink their risk tolerance. The disappointment of 2015’s performance will likely reinforce that wariness of the equity markets. An RRSP that closely tracks the TSX would have been down 8.32% last year. That account will have to appreciate by 9.08% just to get back to the values at the beginning of last year. Given average return expectations of 8% per year, it will take 13 months just to recover, let alone get ahead. (And the numbers get worse if you go back further – the TSX is still below the high it reached in 2008.)

Even after our inauspicious start, 2016 may be a great year for equities, or it could be a repeat of 2015 (or worse). Either way, the safer, more reliable route to a more secure portfolio is to decrease downside volatility by employing two of the touchstones of risk mitigation: diversification and non-correlation. Both allow portfolios to absorb and offset downdraft periods, while benefiting from the correlation between return and risk (most assets with a higher-return profile also carry a higher-risk profile).

One of the greatest sources of volatility for a portfolio is the particular market or strategy it’s primarily invested in. The TSX, as an example, has historical volatility of more than 15%, which is quite high. To offset this inherent risk, it’s necessary to incorporate additional components that are both uncorrelated to the TSX and to each other.

Finding diversified, uncorrelated components is easier than you may think. There is a range of non-equity investment options available for RRSPs. Real estate, infrastructure and lower-risk funds of alternative funds can all be beneficial components of a balanced RRSP portfolio. Even the traditional RRSP component of Canadian equities can be turbocharged by replacing a long-only mandate with a long-short manager. And all of the above are available to accredited investors in bite-size pieces appropriate to an RRSP.

As with all portfolios, when constructing an RRSP portfolio, it’s important to distinguish the particular characteristics of each component so the portfolio achieves the greatest possible appreciation with the least possible risk. Real estate and infrastructure both have valued histories as long-term wealth generators with lower volatility, but they usually come with liquidity restrictions, and each is subject to cyclical trends. Funds of alternative funds can combine lower risk and reasonable liquidity while offering access to a range of investment themes far beyond the Canadian economy, an important way to break out of the limitations of living in a country that constitutes less than 3% of the world’s GDP. Long-short equity can achieve market neutrality and have great liquidity, but even some of the better Canadian funds can be highly volatile.

Your investment advisor should be able to suggest suitable choices for each component, and you can evaluate those recommendations (and come up with alternatives) by doing some internet research of your own. When assessing providers for each component, you and your advisor should consider the usual metrics such as beta, volatility, standard deviation, Sharpe Ratio and correlation to the TSX. While the names may be new to you, the concepts are easy to grasp and very useful when comparing performance over time. When it comes to choosing a fund of alternative funds, identify a manager with a proven record of nimbleness, as he or she will have to keep updating the mix of exposures to benefit from evolving market conditions.

Many pundits agree we are likely in the final innings of history’s longest equity bull market. Additional headwinds may result from bonds and credit, beginning a long overdue tightening cycle, which many are expecting will increase volatility. Now is the time for investors to rethink portfolio construction and embrace asset classes that are less influenced by the equity markets. Sophisticated investors like family offices and institutions embraced non-correlated alternatives decades ago. It’s time for the rest of us to catch up.

Ari Shiff is president and chief strategist of Inflection Management Inc. (inflectionmanagement.com), and manager of the Inflection Strategic Opportunities Fund. He has more than 20 years experience in hedge funds and can be reached at [email protected] or at 604-730-9147.