Its that time of year, during the month of February, when we hear non-stop commercials from the major financial institutions about RRSP this and RRSP that. Get a loan. Invest now. It goes on and on. I wanted to briefly comment on this fervour in an informing way that I hope will dispel some myths and encourage some sound behaviours.
What is an RRSP?
Quite simply, an RRSP is an account that is registered with the Canada Revenue Agency as a retirement savings account. This registration allows investments held within the account to grow without the yearly impingement of taxation on the investment earnings. This registration also causes the CRA to allow RRSP contributors to deduct the contribution from their income and deferring that taxation until the contributor withdraws the funds. There isn't really much more to it than that.
It works like this:
January 7th, 2007, Joe puts $1000 into an RRSP account and buys a 4% GIC. During 2007 he earns $40 of interest income which he is not taxed on because it is within a RRSP account - this protection continues until he withdraws the money from the account. He also receives a slip as a confirmation of his contribution and he is allowed to deduct that from his 2006 income resulting in a $200 to $400 tax refund, depending on his marginal tax rate. Don't worry about the CRA though, Joe will pay those taxes back plus more when he withdraws his money, hopefully in retirement!
If Joe invested that same amount of money in a non-registered account he would pay $8 - $20 of taxes on his $40 of interest income every single year, depending on his marginal tax rate. Of course that taxation reduces his overall rate of return.
Why is an RRSP account good or bad?
Canadians, given the right circumstances, should use RRSP accounts for the obvious benefit of allowing the investment earnings to be untaxed until withdrawal. From what I see, this is not why most Canadians have an RRSP account. Most have simply just followed the advice of their financial institution not really giving much thought to actual retirement or investment planning. This isn't necessarily a bad thing since it encourages people to set aside money for the future, something that is quite important, but it is generally done with the care and planning it should be done with.
What I see on a day to day basis is the obsession with the yearly tax deduction and a general lack of care and a misunderstanding about the actual investment choices within the RRSP account. The majority of people display their misunderstanding by referring to an RRSP as an investment - it is not an investment - it is only a type of account which can hold investments. The annual obsession is also harmful in another way, which is, not encouraging a regular dollar-cost-averaging plan which would involve regular monthly or weekly contributions. This method is far more disciplined and results in more savings and better investment growth over the long term. It also helps people avoid things like RRSP loans and the mad scramble for cash at a tough time of year.
All of that said, many Canadians do make good choices about using RRSP accounts for the obvious benefits and do understand the positives and negatives associated with these accounts.
What are some of the social behaviours you have witnessed regarding the RRSP season?