This is part one of our five-part #TaxWeek series on everything you need to know about filing your return this year. Here's a recap of the entire series.
It’s that time of the year again — RRSP season.
Annnnnd your eyes just glazed over.
But stick with us. This isn’t just another boring RRSP article. It involves beer, drunk millennials, and a tax expert forced to entertain our questions — all in search of the knowledge to help you make more money this tax season.
We’ll be the first to admit that RRSPs can be painfully dry and confusing. They’re also one of the most powerful financial tools we have access to. For those Canadians just starting to think about long-term money planning, or even for those well on their way to a comfortable retirement, it’s important to understand the particulars of this popular tax shelter — which, by the way, is almost at retirement age itself.
Here at LowestRates.ca, our content team is a pretty young bunch, ranging from 24 to 34. So we’re in that age bracket where the RRSP is increasingly creeping into our lives. With the March 1 deadline to contribute quickly approaching, we wanted to learn more.
And who better to explain the RRSP to us than Toronto-based, MoneySense Approved Financial Advisor, Joe ‘The Investor’ Barbieri.
[A bunch of millennials pour into the room with Joe, who looks visibly amused. One or two may have been pre-drinking.] Alright Joe, we need to start with the basics. What the hell is an RRSP?
OK, I’ll give you the definition: It’s a Registered Retirement Savings Plan. So if you look at the words, ‘savings plan’ is one hint’, ‘retirement’ is the other, and ‘registered’ means the government knows about it. Because you could save without the government knowing about it, but the reason why you have a registered account – and it’s important to remember it’s an account – is so that it can be tax-favoured. So really, it’s a tax strategy more than an investment thing.
A lot of people say they ‘invest’ in RRSPs, but they don’t actually know what they’re invested in. You can acutally invest in a lot of different securities within an RRSP, and then pay taxes later, when you retire.
We hear a lot of competing advice around what to put in our RRSPs — whether it’s ETFs or mutual funds, or using a robo-advisor like Wealthsimple. How often can people change what’s in their RRSPs?
Anytime, as much as you want. The only thing to remember is to keep it registered. You can switch investments from one bank to another — just remember to use the word transfer. There’s a form you use to tell the government you’re not withdrawing, you’re moving it, so please don’t tax it. It’s a bit of a pain sometimes, but you can do it as many times as you want.
I can't remember the last time I walked into a bank branch
So essentially the RRSP is a way the government is encouraging its population to save?
Yep. And they do it with the tax break. It’s actually a tax deferral – which just means you’re going to pay later. TFSA is tax-free; it’s different. So let’s say you open up a new RRSP account and you make $50,000 in income, you contribute $5,000 into your RRSP account, you get a slip at the end of the year saying ‘I contributed $5,000’ and you put that on your tax return and you’ll get a refund at the tax rate you would’ve paid. [Lowestrates.ca jumping in here — if you contribute $5,000 with an income of $50,000, you’re essentially saving that $5,000 from being taxed at the federal rate of 20.5% for that particular tax bracket. So that’s a cool $1,000 back]
How many RRSPs can you have?
You can have as many as you like. The only limit is how much you put in, and when you put it in. But as long as the total amount is under the limit that they tell you. [More on this later.]
This might be a stupid question. But how do you open an RRSP? Just go to any bank? I can’t remember the last time I walked into a bank branch.
Yes. It’s like a bank account. You fill out a form. But there are a lot of different kinds of RRSP accounts. So if you want a cash account, you can set that up easily at a bank. You could also have a mutual fund or an investment account or a trading account – they can all be RRSP, but they have different things in them. So that’s why I say it’s an account, not an investment. People tend to put them together, but you should think of it as two pieces: the tax piece and the investment piece. The RRSP being the tax piece.
So you fill out an application, the institution registers it as an RRSP with the government, and when they send it to the CRA, they say: ‘OK we acknowledge it.’ Then – bang – it’s in their record. Then when you do your tax return, they’ll match the number that you get with their database and recognize it as a real RRSP account. Because you can fake a contribution.
How do you fake a contribution?
Well, you can fake a lot of things.
You can create a slip from an institution with the letterhead and everything…
[This piques the interest of one of our writers, who looked bored up until this point.] “Oh, like serious forgery…”
Serious forgery. But it doesn’t work, because the institution is sending everything to the government as well as you, and the government matches it. So if you do that, the institution doesn’t have it and the government will be like ‘Hey, where did this come from? The bank never told us you contributed.’ And then they’ll flag it and check it and say 'buddy, you’re stealing.'
And people do try to cheat.
I did taxes for a company and somebody tried to fake a T4 slip. They literally photocopied it, put a company name —they made it look real and they actually got a refund. Then the guy doing the return noticed something fishy and flagged it. It was a Home Depot return at King and Bathurst. Just picture King and Bathurst downtown – definitely no Home Depot there. He called the cops and they came and took the guy away.
What is the annual contribution limit?
The first year you work, you build room. So you have zero income and then you make $50,000 — they take 18% of that as the room for next year. And they have an upper limit. So if you make $500,000 [the cap for the 2016 tax year is $25,370]. If you don’t use your room, it accrues. And if you have a company pension, that goes into the same pool. So that room is really retirement room. If you’re doing it all yourself, it’s RRSP only. If your employer is helping you – say they give you a pension and put in $5,000 – that counts against your limit, too.
In order to contribute, you have to know you've got extra money, and who knows?
What’s the earliest you can start contributing?
You have to be at least 18-years-old.
Some surveys lately are showing that many young Canadians cannot name a single thing you can put into an RRSP, nor are they contributing. What’s going on here?
Well, I’m going to take a guess. Most of my clients are seniors, but I’m getting more people in their 40s and and I’m getting some millennials now. They’re actually pretty knowledgeable, but a lot of them don’t have the money, student loans is a big problem (and they last forever and they’re expensive), and I usually tell them – just pay the student loan. You’re better off then trying to gamble on picking stocks or funds. If you pay the student loan at 8%, you’re pretty much ahead of the curve. It’s guaranteed and there’s no risk. So a lot of it is about getting rid of debt. That’s what I tell them, and a lot of people do it, and then say: ‘Well, thank you very much, I don’t need an RRSP.’
The money’s just not there for them and the predictable income isn’t there. In order to contribute, you have to know you’ve got extra money, and who knows? If you’re self-employed you don’t know, launching a startup you don’t know, or if you’re between jobs you don’t know.
The TFSA, on the other hand, is appealing because you can take the money out and there’s no consequences. The RRSP, you’re going to get taxed, and if you don’t play it right, you might actually be worse off.
Do you think younger Canadians are less financially literate than previous generations? Are you worried about this generation?
Actually, I’m not.
I see this generation as the inventors, the entrepreneurs. So I think of it as my grandparents, because I notice a lot of people are starting companies, creative crowd-funding, startups, little community businesses. All of that takes creativity and it’s hard. You have to be really resourceful and really out-of-the-box. I was sort of the last group to think of careers as ‘go get a job, stay there, etc.’. We had that idea going in: ‘If I can get a job for 20 or 30 years, build up my assets, I’m done.’ But around sometime when I was in my 30s, it kind of disappeared. We basically started moving, chasing the money, chasing the promotion, chasing wherever you could get more growth or opportunity, but eventually you hit the limit. And once you reach 45 or 50, you’re old; even for senior analyst positions, you’re considered old. So you eventually peter out, then you either go on your own or you try to hang on and retire early or bail out early.
But the newer generation won’t go through that. They’re going to start something right away. And if you do that, you’re going to be doing that all the time. Even if you have zero to work with, you’re going to be able to make it. But the people older than me wouldn’t be able to do it. They’re so used to a steady paycheque, predictable income, but unless you’re really established and almost stale, it’s hard to find it.
Some people think they have to have money in RRSPs, but there really aren’t many have-to’s in finance.
It’s like the RRSP was designed for a different generation.
Once upon a time, there were no RRSPs. What did people do? The company saved for them – called a pension plan. And it was defined benefit, which means the company did everything; all you had to do was contribute, and they even did that for you. And when you retired, they paid monthly income. You didn’t have to do anything.
It sounds fake.
Well, no, it’s real.
[Everyone in the room looks at Joe skeptically.] Alright, next question. Do you foresee robo-advisors playing a bigger role in how people approach their RRSPs?
I think so, yeah. The big advantage that I see is in keeping it balanced. On maintaining accounts, people tend to be not very good. They forget what they have and they get busy. They don’t want to bother – they just want to buy it and leave it. And sometimes things drift – we call it ‘portfolio drift’. So if I buy 10% of every sector, one of them’s going to go up, one of them’s going to go down, some will stay the same. If I don’t do anything, in 10 years everything will be unbalanced, and that introduces risk. So what the robo-advisors are good at is going in every period and going ‘ah, this one did really well, let’s re-balance it; this one did poorly let’s add to it.’ And it does it automatically — you don’t have to be watching it as much. But I still believe you should look at it, period. Because you have to make judgment calls and the computer can’t do it.
But once you hit $100,000, well then I think there’s less of a case to be made for robo-advisors.
I did taxes for a company and somebody tried to fake a T4 slip. They literally photocopied it, put a company name, they made it look real
So there’s actually a threshold where you recommend going on your own?
Yep. When you do that math, you realize there are ways to cut the fees by buying ETFs, and still get the same exposure, and same type of investment. But if you had only $10,000, you can’t do it. You have to compare. As you get more and more money, the fees go up, but with an ETF, they’re flat. So eventually you hit a point where it’s not worth it anymore.
And now a lot of people are starting to look for human advisors to complement robo-advisors. Now I don’t know how widespread this will become, but apparently that’s what’s happening. And if that happens, it’s going to change the game — again. It’s going to become a team effort. So they’ll hire an advisor to do the complicated things and they’ll outsource the investments to one of the robo-advisors, and it will become a combination. And especially for people with more money, I think we’ll see more of that.
To me, it makes more sense to just never touch my RRSP until retirement [says the only parent on the content team]. Do you think there’s a case to be made for using your RRSP for a down payment?
Here’s the math: you compare the interest rate on the mortgage with the investment interest rates. Right now the mortgage rates are really low so it’s easier to keep it in the RRSP and invest it, because you’ll probably on average do better. [Quick example, if your mortgage is 3% per year and you’re averaging a 6% return in your RRSP, keep the money in the RRSP.] If the rate on the mortgage was 10% — and they’ve been that high in the past — I would say it’s reversed, because then you’d have to beat 10% in your portfolio.
Have you come across any common misperceptions that middle-aged Canadians have about RRSPs?
Some people think they have to have money in RRSPs, but there really aren’t many have-to’s in finance. For example, people that own businesses might be better off without an RRSP. If you’re a business owner — especially of a corporation — it’s different. The corporate income tax is much lower than any personal bracket you could be in; it’s about 11%. So a lot of people just leave money in their company and use that as their pension, they don’t ever have RRSPs or TFSAs. I did the math, and they’re right. It makes more sense to just leave it in their companies.
So people think they have to have RRSPs, but there are cases where you don’t. Another one is pension plans. If you have a rocking solid pension plan and they contribute most of your room, you don’t need an RRSP. They’re doing it for you. So you can put your money somewhere else.