Contributing to an RRSP

Two major benefits to the RRSP is a worthwhile component to your financial plan. First is the immediate tax savings which you gain from a contribution to the plan.

Contributions to a registered retirement savings plan. can be made during the year and within the first 60 days of the following year can be used as a deduction from your income when your tax refund is filed.

The other major benefit to contributing to your Registered Retirement Plan is the tax-deffered savings. What this means to you is the investments in your plan can earn income such as interests, dividends, or capital gains.

However, the earnings inside the registered retirement plan will remain tax sheltered un they are withdrawn from the plan at which it will be taxed as income.

Even better news...

Given that the returns are not taxed inside the plan, this allows for your investments inside it to continue to accumulate tax-free earnings that will compound the growth of the investment.

The plan is one of the most common and easiest ways to shelter your income from tax for a long period of time and also play an important role in achieving your retirement goals.

8 Ways To generate more money in your RRSP

1. Contribute as much and as early as you can.

Time, money, and tax savings are ingredients for growth in your plan.

2. Consider a spousal plan.

You get the tax savings while the money compounds tax-free in your spouse's name. Even better at retirement this means two lower tax brackets instead of one higher one.

3. Invest outside of Canada.

With the foreign content rules relaxed, international investing can build greater stability through diversification. What does this mean for you? New growth opportunities

4. Consolidate your plan holdings for easier record keeping and better growth.

There's no limit to the number of plans you can own. But to minimize fees and maintain more control over your portfolio, it may be a good idea to consolidate your RRSP holdings.

5. Consider borrowing to contribute.

With interest rates being so low it may make sense to borrow money to invest in a plan as long as the RSP is earning a good rate of return and you pay off the loan promptly.

Although your borrowing costs are non-deductible, you can use your tax refund to reduce your debt. Plus, you'll have a bigger nest egg for retirement.

6. Look into starting a Pre-Authorized Chequing Plan.

This is a convenient, no cost way to contribute to your plan directly from your bank or trust company account.

7. Avoid taking a short-term view.

The plan makes money for the long-term. So your investments should be long-term in nature. All good investments will fluctuate over time.

8. Maintain a good mix of asset classes.

The two most significant asset classes are fixed income securities, such as bonds and mortgage backed securities and equities (stocks). Research has shown that a mixture of both will have an impact on your growth in the long-term.

What is the best mix? That is up to you and what you feel most comfortable with. But do not let that comfort level stop you from investigating how you can boost the growth of your plan.

How Entrepreneurs prepare with RRSP savings

If your plan contributions are any indication, small business owners are better prepared than most for retirement. According to a recent CIBC report on Canadian Entrepreneurs and Retirement, more than two-thirds (70%) of entrepreneurs have a registered retirement savings plan, compared with 55% of paid employees.

Entrepreneurs also contribute about 50% more to their plans than their employed counterparts without a pension plan.

Clearly, many small business owners bring the same careful forward planning to their retirement objectives as they do to their business objectives. With that in mind, these strategies have the potential to enhance the performance of your plan.

Contributing the maximum. The salary you draw from your business will determine the size of your RRSP limit the following year, up to the maximum. You can contribute up to 18% of your previous year's earned income (less any pension adjustment), to a maximum of $15,500 for the 2005 taxation year, rising to $18,000 in 2006 and $19,000 in 2007.

To reach the maximum $18,000 contribution limit for 2006, you would need to report earned income of $100,000 in 2005 (that is, $100,000 x 18% = $18,000).

Remember, you have the first 60 days of the year to make your contribution for the previous tax year.

Diversifying. Whether you're investing inside or outside a registered plan, diversification remains one of the most effective ways to improve potential performance and decrease volatility.

In addition to being diversified across the three main asset classes (cash, fixed income, and equities), you may want to diversify geographically. And with the foregin content rules done away with diversification has become even more important.

Income splitting with your family. If you run a family business, you can pay your spouse and children a reasonable salary for duties they perform in the business. This earned income, which is usually tax-deductible for your business, may generate contribution room for their own plans. (keeping in mind their pension adjustment, if any).

Even if your children are still in their teens, and don't have a plan, the accumulated contribution room can be carried forward into their adult years and used to reduce taxes.

Avoid losing money in your RRSP

I recently made a big mistake. I took Michael, our youngest child, to the hardware store. Now, darkening the doors of the hardware store itself wasn't the problem. But visiting the store with a potty-training child who wasn't wearing a diaper, and stopping in the plumbing section by the toilets was not a smart more.

Do you think I can convince the little guy to go on the potty at home? Not a chance. But turn the other way for 20 seconds at the hardware store and his pants are down to his ankles as he's doing his No.2 in aisle No.3 sitting on a toilet bowl.

No diaper Big mistake. It's not uncommon each year for thousands of Canadians to make some big mistakes of their own - with their registered retirement savings plan. Let me explain with examples I have encountered over the years

First mistake

You've got to feel for a man we'll call Jason. He called me in dire need of some tax help. Jason sold some last year for $100,000 profit. Without any planning Jason was destined to pay taxes of $23,205 on this capital gain.

No wanting to suffer this type of tax bill, Jason did what many quick-thinking investors would do. He identified several stocks in his portfolio that had dropped in value, and decided to trigger $80,000 in capital losses, to largely offset his capital gains.

Jason's problem? He simply transferred the losers into his plan, as a contribution in-kind. His thinking was that he'd be able to claim the $80,000 in capital losses, and an RRSP deduction to boot, which would then offset all the tax on his gains.

Jason didn't realize that when you transfer any investment directly into your RRSP, it's considered to be a disposition at fair market value, but any losses on the transfer are denied. This mistake cost him $18, 564 in tax. The solution?

He should have sold his losers on the open market, then contributed the cash to his plan. This would have given him the result he was looking for.

Second mistake

A woman we'll call Janet also learned the hard way. Her husband had contributed $30,000 to a spousal RRSP for Janet over the years 2002 and 2003. By mid-2004, that $30,000 had dropped in value to just $2,000.

Oops. Now, rather than having two plans, one worth just $2,000, Janet decided to combine this spousal RRSP with her own RRSP to which she contributes each year.

Her own RRSP was worth about $50,000 at the time.

Since Janet was not working in 2004, she decided to make a $20,000 withdrawal from her RRSP. What she didn't realize is that when you combine spousal RRSP dollars with regular RRSP dollars, the entire plan becomes a spousal RRSP.

That's right her $50,000 RRSP became entirely a spousal RRSP since she had added $2,000 of spousal RRSP money to the plan.

The result is that the full $20,000 she withdrew from her RRSP will be taxed in the hands of her husband, who is in the highest tax bracket. Yikes. This mistake cost the couple $6,641 in tax.

The solution? Janet should have avoided transferring spousal RRSP dollars into her own RRSP. Then, she, not her husband, would have faced the tax on the $20,000 withdrawal.

The only time you can avoid this "tainting " of regular RRSP dollars with spousal RRSP status is on separation or divorce. Even then, speak to a tax professional to ensure you're doing things properly.

Tim Cestnick, FCA, CPA, CFP, TEP is the author of the Tax Freedom Zone and Winning the Tax Game, among other titles. (visit the bookstore to see more of Tim's work)




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