Our Favorite Way to Save
RRSPs aren't just for retirement anymore
There was a time when the only thing a Registered Retirement Savings Plan (RRSP) was used for was saving for retirement. The advisor-mantras, "Never touch this money" and "An RRSP is a long-term investment" echoed through the pages of the popular press. And, for as long as RRSPs were just for retirement, investing the assets accumulated were a simply exercise in balancing your willingness to take some risk against the kind of return you expected to earn.
But RRSPs aren't just for retirement anymore. The government allows us to use our RRSP as a savings plan for a downpayment on a home. It allows us to use our RRSP to finance your on-going education. And those who wish to raise a family or go on sabbatical have long employed the RRSP as an income-averaging tool. It's even used as an emergency fund by those who have suddenly found themselves unemployed. It would be fair to say that the RRSP has become Canadians' favorite savings account.
The problem with an RRSP being all things to all people it that its wider scope, its greater flexibility, its move from a hands-off-don't-ever-touch-the-money retirement plan to a you-can-use-it-whenever-you-can-justify-it savings account is that the process of identifying your investment strategy has become more complex.
Most people say they don't have enough money to maximize their RRSP and set aside a non-registered emergency fund, which at least in part explains the overlap between retirement savings and other types of savings that often takes place within an RRSP.
One of the first questions you have to ask yourself when you're trying to choose investments for your RRSP is, "When am I going to use this money?" If you're using a portion of your RRSP savings as your emergency fund, then you'll need to keep that portion of the RRSP assets fairly liquid so you can get at the money if an emergency arises. And if you're going to tap your RRSP within the next year or three to buy a home, that money isn't destined for long-term investment. You've got a short- to medium-term investment horizon and must choose investments that suit. So you'll have to forgo equities in favour of a more conservative investment portfolio. Since you don't have the time to wait out the bumps in the road that are part of the equity-investment experience, you'll have to settle for less return.
Being clear on how you plan to use your RRSP dollars is especially important when those dollars are being contributed to a spousal plan or the contributing spouse could find money withdrawn from that plan taxed in his or her hands. That's because the rules for withdrawals from a spousal RRSP state that if money is taken from a spousal plan within three calendar years of a contribution to ANY spousal RRSP, that money could be taxable in the hands of the original contributor. And that of course would completely defeat the income-averaging strategy the couple had set out to use.
Make spousal contributions by the end of the calendar year, as opposed to the first sixty days of the new year since spousal contributions are measured on a calendar year basis. If you delay your contribution until January, you'll end up extending the withdrawal period by another calendar year.
If you've recently lost your job, you may be thinking of using your RRSP as a source of income while you search for another. That can be a good plan, particularly where you received a severance that eligible for rollover to an RRSP. Keep a portion of any severance you've rolled to your RRSP fairly liquid until your probation period [at a new job] is over. Laid off late in the year? Try to hold off taking withdrawals from your RRSP until the new year if you think you may be in a lower tax bracket.
Most advisors agree you should rollover as much of your severance as you're eligible to. For those people who have more severance than rollover room, this would be the time to catch up all that carry-forward room.
Perhaps the toughest part about using your RRSP for myriad purposes is keeping track of which of your RRSP dollars are for what. Here, consolidation may work against you. Instead, consider opening up a separate RRSP for each of your purposes and file your statements based on what you're trying to accomplish. So all those Bank of Montreal statements would go in your "Home Ownership RRSP", while your TD Canada Trust statements would go to your "Retirement RRSP". Separate accounts will not only help you stay focused on the purpose for which you are saving, it will allow you to keep your time horizon in perspective.
As you get closer to your objective for that plan your investment horizon changes and so, too, should your asset mix. If you're planning to return to school seven years down the road, you might remix your portfolio at the five-year, three year, and one-year marks.
Finally, while the money in your RRSP is your money and you get to decide how to spend it, it's important not to sacrifice your long-term goals for short-term ones. It's easy to get focused on a single objective to the exclusion of all others. But to be balanced, you need to be taking a look at what you want your savings to do for you long-term, as well as short- and medium-term. So, if you're saving for a home, instead of putting this year's total RRSP contribution into your "Home-ownership RRSP," consider dividing it equally between home ownership and retirement. Yes, it will take a little longer to get into your dream home. But when you do, you won't be behind the eight ball in terms of retirement planning.