Debunking Common RRSP Myths – What you need to know
To get you up to speed on the RRSP, take a look at this quick video:
Coincidentally the Registered Retirement Saving Plan (RRSP) turned 60 last week and like many reaching that milestone, it has no plans of retiring. Retiring can be an intimidating feat, especially considering recent studies suggest that, depending on your relationship status, median living costs, and average income, you need at least $750,000 CAD by the age of 65.
Thankfully the Canadian Government introduced RRSPs. For those unfamiliar a Registered Retirement Savings Plan (RRSP) is a unique type of savings account for holding savings and investment assets. RRSPs have various tax advantages compared to investing outside of tax-preferred accounts. They were introduced in 1957 to promote savings for retirement by employees and self-employed people. Since conception a lot of RRSP misunderstandings have developed. So let’s dive into two of them.
Myth #1 – You can’t manage your own RRSP
A lot of this boils down to personality. Do you have an individual appetite for risk? Are you risk aversive? If you are comfortable leveraging your retirement savings, then other options exist – and they are becoming increasingly popular.
You can open independent portfolios or accounts through your financial institution. If you are unhappy with the scope or diversification of your advisor’s mutual funds, then you do have ability to do it yourself through Self- Directed RRSP’s.
“self-directed RRSPs have become a popular retirement savings vehicle for many Canadians. Edward Kholodenko, president and chief executive officer of Questrade, a Toronto-based online trading service, says the expansive breadth of investment choices, combined with comparatively lower administration fees and the convenience of online access, makes self-directed RRSPs highly attractive to investors.” (Globe and Mail Interview)
However, please proceed with caution. To ensure this increase in control translates to a healthy RRSP portfolio, it’s important for investors to be well prepared, says Rowena Chan, vice-president at TD Waterhouse. “You need to get all your information together – your goals, your current financial situation – and be willing to do some research so you at least know the basics of investing,” she says (TD Self Directed Investments). A happy medium is to have self-directed portfolios with the ability to report to a broker. A hybrid model satisfies the need to go at your own pace but also lends the security of having a professional to audit your decisions.
So we now know the ability to control your financial future exists, just remember to educate yourself. There are plenty of free resources out there. Still unsure? Set up a meeting with your broker to feel out your options.
So let’s considered this issue debunked.
Myth #2 – TFSA’s yield better returns
The RRSP is not the only investment vehicle that is appealing to those looking onward to sandy beaches and afternoon mimosas (the dream retirement). The introduction of Tax Free Savings Accounts (TFSA) in 2009 meant competition for RRSPs. A TFSA is an account that provides tax benefits for saving in Canada. Investment income, including capital gains and dividends, earned in a TFSA is not taxed, even when withdrawn. However, RRSPs continue to stack up against TFSAs. With the introduction of the Home Buyers Plan, Lifelong Learning Plan, Income Tax Savings, and the ability to do pension income splitting.
This chart for the Globe and Mail simplifies the differences between contributing to a TFSA versus an RRSP:
As you can see, the main difference between these two savings plans is the difference in when you pay taxes. For a TFSA, you income is taxed when you earn it, and it reduces your net contribution limit. For your RRSP, your income is not taxed when earned, but is taxed when it is withdrawn.
It’s important to note here however, that this chart assumes that your tax rate doesn’t change in retirement. When you are in retirement, your tax margin is decreased, which would actually allow your RRSP account to outperform the TFSA in this situation.
The major difference between the TFSA and RRSP is the ease of removing funds from the TFSA. This is actually a bit of a risk however – the Wealthy Barber, Dave Chilton from Dragons Den, had some very insightful words about this point:
“I’m worried that many Canadians who are using TFSAs as retirement-savings vehicles are going to have trouble avoiding the temptation to raid their plans. Many will rationalize, “I’ll just dip in now to help pay for our trip, but I’ll replace it next year.” Will they? It’s tough enough to save the new contributions each year. Also setting aside the replacement money? Colour me skeptical. The reason I always sound so distrustful of people’s fiscal discipline is that after decades of studying financial plans, I am always distrustful of people’s fiscal discipline. And even if I’m proven wrong and the money is recontributed, what about the sacrificed growth while the money was out of the TFSA? Gone forever.”
He leaves us with note:
“Reminders: (1) If you go the RRSP route, don’t spend your refund; (2) If you go the TFSA route, don’t spend your TFSA; (3) Whatever route you go, save more!” (Globe and Mail Interview)
At the end of the day, TFSAs and RRSPs can preform equally well but it ultimately comes down to your own personality risk. There is no official ruling either way. We can call it a myth debunked.
The main objective of this article was to get your head around the importance of being financially literate and highlighting the feat of retiring. Both RRSP’s and TFSA’s accounts can be great options to helping you achieve your retirement goals. This can be done by using self-directed accounts (do it yourself) or through a financial professional. The best use of one or both of these types of savings vehicles will depend on your unique situation.
What we can all be sure of now, the sooner you start to save, the better off you will be for retirement. Speaking to an advisor can be very helpful in providing some clarity to these situations.
Thanks for reading!
Thanks for reading!
If anything on this blog interests you further, please do not hesitate to reach out to me via email at [email protected] I’d love to talk about my financial services and advice in Vancouver, British Columbia’s lower mainland, and Canada in general.
- Brad Blair, CFP, CIM, FCSI, CHS.