Why You Should Save Within an RRSP

 By now most of you will have received your Notice of Assessment from Canada Revenue and know the amount you can contribute to your RRSP for tax year 2008. But the stock market is going nowhere; bond and treasury bill yields are down; the sub-prime crisis is still front-page news, and economists are looking for declines in second-quarter GDP. Put money into an RRSP now? You must be kidding!

 No, we're not kidding. This is the very time to be investing. Remember, the old cliché, "buy low and sell high"? The wise person looking to build an RRSP will see the current market as an opportunity to invest.

 The RRSP is the best retirement savings vehicle in Canada. About 68% of Canadians have RRSPs, an increase from 57% in 2002, according to the RBC Asset Management-Ipsos Reid 18th annual RRSP poll conducted last fall. The average planned contribution for the 2007 tax year was $5,967, almost double the $2,866 of 1993 but substantially below the 2007 allowable limit of $19,000. The $20,000 limit for 2008 rises to $21,000 in 2009 and to $22,000 in 2010.

 Consider the following benefits and you may well wonder why everyone, even teenagers with part-time jobs, doesn't start saving as soon as they earn eligible income.

 Saving is for More Than Just Retirement

 An RRSP provides the contributor with an immediate tax benefit. For example, a person in a 23% personal tax bracket who invests $1,000 will enjoy a tax savings of $230 for the year in which the contribution is made. Granted, this contribution and any gains resulting from it become taxable when the retirement funds are withdrawn, but the immediate reduction of taxable income provides a present benefit by increasing cash flow. If your marginal tax rate at retirement is 23%, withdrawal of $1,000 will still generate only $230 in tax but the original $1,000 will have had the opportunity to grow sheltered from tax through the intervening years.

 Taxpayers can also contribute a portion of their allowable limit to a spouse's or partner's RRSP. The contributor enjoys tax savings in the current year and both may benefit from income splitting upon retirement if one is in a higher income tax bracket than the other. Recent amendments to the Income Tax Act have broadened income splitting opportunities for couples who can now jointly elect to split eligible pension income.

There are very few situations in which the Canada Revenue Agency is willing to forego the tax on income in the year it is earned. Dividends, interest, and capital gains earned within an RRSP are such an exception; they go untaxed until withdrawn. This period of tax deferral can last from the moment of opening an RRSP as a teenager until the end of the year in which you turn 71, when you must start making withdrawals.

 If you hold taxable assets outside an RRSP at the time of your death, they are deemed to have been sold at the date of your death. Capital gains taxes are paid on half the capital gain and income taxes are paid on any interest or dividend income earned up to the date of death. If you held the same assets in an RRSP, the entire RRSP is transferred intact to your spouse or common law partner without tax and continues as an RRSP in his or her hands. This is comforting to survivors who may find themselves in uncertain financial circumstances after the death of a partner.

 The Income Tax Act also provides other opportunities for taxpayers to transfer taxable property on death to their spouses or partners on a tax-deferred basis.

 The need to provide for financially dependent children or grandchildren after your death is another reason for saving within an RRSP. Funds designated for a qualified child or grandchild receive tax treatment similar to that received by the surviving spouse. This feature provides the opportunity to provide for those who may not be able to fend for themselves after your death.

 RRSP savings act as a safety net. Knowing you have RRSP savings available should you lose your employment, encounter a family emergency or business difficulty provides a psychological buffer lacking to those without such savings.

 An added advantage of RRSP savings is the tax disincentive to withdraw RRSP funds before the plan matures. The institution that holds the RRSP is required to withhold and submit to the CRA 10% (5% in Quebec) on amounts up to $5,000; 20% (10% in Quebec) on amounts from $5,000 to $15,000; and 30% (15% in Quebec) on amounts over $15,000. The amounts withheld may not be enough, however, to pay the tax on these withdrawals required by your tax bracket. The possible tax consequences of withdrawing funds before maturity should discourage frivolous withdrawals.

 RRSP savings may be withdrawn without tax penalty for participation in the Home Buyers' Plan (HBP) or Lifelong Learning Plan (LLP). Although the amounts borrowed must be repaid according to a CRA timetable, the taxpayer does not pay interest on the borrowed funds. Amounts not repaid as scheduled are added to your taxable income. Since you are actually borrowing your own money from your RRSP to participate in the HBP or LLP, your credit rating is not affected as it would be if you had borrowed the money from a financial institution. And, contrary to what happens when RRSP funds are withdrawn, income tax is not withheld at source.

 RRSP contributors are free to choose their investments, as long as they are prescribed as qualified investments. Indeed, you may even manage your own money through a self-directed RRSP.

 Even if you participate in a company pension plan you believe will provide an adequate income stream in retirement, you should consider reviewing the terms of your plan and the financial condition and performance of the company where you work to make sure it will be there when you retire. These considerations are especially important if the company pension plan is underfunded and retirees are dependent on the current earning power of the company to provide a portion of their income. Membership in a company pension plan limits the amount of RRSP contributions, There are, however, always compelling reasons to contribute to an RRSP even if the company pension plan is excellent:

 •  Your company may not survive until your retirement date

•  Funding may be inadequate if investments do not provide adequate returns

•  Early retirement or dismissal may reduce your anticipated pension

•  Plans are usually subject to rules that restrict the use of pension funds

•  Most plans do not allow withdrawals for emergencies

•  Allocation of funds to your partner's retirement plan may be impossible

•  You have little or no control over company investment policy

Your RRSP Safety Net

 Saving within the shelter of an RRSP is an excellent life-long personal financial-planning strategy. With help from accredited financial advisors and tax advice from your chartered accountant, funds placed within an RRSP will provide not only a safety net on the journey of life but also a stream of income for those golden leisure years.