Fixed-income investments simplified

To diversify your investments you should have a fixed-income component in your portfolio, such as guaranteed investment certificates or bonds.

But you should have an understanding of the different ways of holding fixed income investments and the underlying risk of each option.

Term deposits and guaranteed investment certificates are a common way to hold fixed income.  The return is known and all fees are built into the initial sell price.  If you purchase a one-year $100,000 GIC at 4.5 per cent then you can count on receiving $4,500 and your original capital back in one year.  This certainty comforts a lot of people and the investment is easy to understand.  It is also easy to plan your cash flows.

Holding federal and provincial government bonds are generally considered low risk.  In recent years, GIC returns have often exceeded the returns offered by low risk government bonds.  Investment grade corporate bonds can be another way to purchase fixed income.  The return potential on corporate bonds generally exceeds government bonds and GICs but the risk element increases.

Another common form of fixed income investment is a bond mutual fund or a balanced mutual fund.  A bond mutual fund invests in a basket of fixed income investments.  Depending on the fund prospectus, the mandate can result in significantly different structures between funds.  Not all bond funds are created equal.  Some bond funds are very conservative while others may take on considerable risk.

Conservative bond funds may hold government bonds and investment grade (BBB rating or better) corporate bonds.  Treasury bills, banker’s acceptances, and term deposits are all considered low risk and are common in conservative bond funds.  One of the benefits of holding bond funds is the ability to diversify your fixed income.  Diversification of fixed income can be done through holding different types (issuers), qualities (credit ratings), and maturities (mixture of short, medium, and long term).

The added “diversification” benefit of bond funds comes at a cost often referred to as a management expense ratio (MER).  Regardless of where interest rates are at, it is important to ensure you are not paying an excessive amount to manage your money.

As an example, let’s use a typical bond fund with an MER of 1.5 per cent.  Let’s also assume that GIC rates are currently 4.5 per cent.  Individuals choosing the bond fund option should feel comfortable that the manager can put at least 4.5 per cent in your pocket.  With an MER of 1.5 per cent, the manager of this bond fund will have to take on some risk to earn 6.0 per cent or more. Your return is not guaranteed with bond funds and can be negative.

Riskier bond funds do exist and have very different mandates than the typical conservative bond fund.  Bond funds that hold non-investment grade bonds, also known as high-yield or junk bonds, may certainly have the potential to earn 6.0 per cent or more.  They also have a much higher degree of risk and generally have a higher MER.  Other funds may hold foreign bonds or concentrate in certain countries such as the United States.

We caution investors to understand currency risk before investing in foreign bonds.  For investors with a large portfolio, foreign bonds may provide some additional diversification.  Some bond funds have a small equity component, generally with dividend paying investments such as common shares.  If a fund holds a significant equity component then it is often referred to as a balanced mutual fund (holding a balance of equities and fixed income).

We encourage most investors to keep things simple.  Establish an asset mix and determine the percentage of fixed income that is suitable for your individual risk tolerance. Once the fixed income component is established we recommend most investors stick to lower risk and investment grade options.

Size of the bond market surprises new investors

New investors are often surprised to learn the sheer size of the bond market.  The Canadian secondary debt market is approximately 30 times greater than the total Canadian equity trading market.

If a bond is purchased at its new issue price the value is normally $100 per $100 par value (also known as face value).  However, most new issue bonds are not floated to the general public, but are bought by the large investment dealers such as the Canadian banks.  The general public has access to buy bonds in the secondary market from these dealers where bond prices will be trading at their perceived value based on many different factors such as world or county specific economic news, interest rates, credit rating, etc.

Due to the numerous variables, bonds are rarely trading at exactly $100 in the secondary market.  Bonds that trade at a higher price than their par value ($100), say $102, are said to be trading at a “premium.”  Bonds that trade at a lower price, say $97, are trading at a “discount.”

We will use XYZ bond to illustrate bonds trading at a premium or discount.

The original XYZ bond was issued at 100 with a four per cent coupon and a five-year term to maturity.  Most bonds in Canada pay their coupon on a semi annual basis (twice per year).  Therefore in this case, the client would receive a fixed amount of two per cent per six months on the total face value of the bonds purchased.  After the initial issue date, the price is not fixed and will fluctuate prior to maturity based on several factors as mentioned above.

Bond prices move inversely to interest rates.  Therefore, if interest rates have increased after a year from when XYZ bonds were initially issued, the price of the bond will decrease.

Many clients find this relationship difficult to understand so let’s use an example to illustrate why this occurs.  Let’s say that interest rates rise to the extent that a new five-year ABC bond, which is similar in term and credit quality as XYZ bond, when initially issued at par is paying a coupon of five per cent.  All else being equal, investors would find the ABC bonds more attractive than the four per cent coupon XYZ bonds issued a year earlier.  Therefore the market in general would sell the XYZ bond, causing the price to drop, in order to buy the more attractive ABC bond.

The opposite may happen to bond pricing if interest rates decline.  If new bond issues are currently paying three per cent coupon, the market would be more inclined to buy higher coupon paying bonds such as the XYZ bond paying four per cent.    The market would buy the XYZ bond, pushing its price above those that are issued at three per cent causing the XYZ bond to trade at a premium.  If XYZ is trading at $102, the premium above $100 can be seen as payment for a higher coupon.

Here are some key tips in acquiring bonds;

  • Never buy a bond solely on the coupon alone.  Yield to maturity for bonds is often the more important number to review as it allows bonds of different coupons and maturities to be compared to each other.  Yield to maturity is the total return, made up of interest and repayment of principal that you will receive if you hold the bond to maturity.
  • For taxable accounts, you should ensure that you are reporting all capital gains from bonds purchased at a discount and all capital losses from bonds purchased at a premium.
  • The coupon component on bonds is considered interest income.  We encourage investors to hold investments that generate interest income within a registered account, such as an RRSP or RRIF, if they have the option.
  • If you are an investor in a high tax bracket and have bonds in a non-registered account, consider those trading at a discount.  Bonds trading at a discount will result in both interest income and capital gains.  The taxable capital gains is more tax efficient than the interest income component.  Naturally, the higher your tax bracket, the greater the benefit of investing in bonds trading at a discount.
  • If you have capital loss carry forwards and are avoiding equity markets then you should ask your advisor to look for bonds trading at a deep discount.  This will convert part of your total return to capitals gains.  The capital gain component generated on a bond held to maturity may be offset by your capital loss carry-forward room.
  • We recommend sticking to “vanilla” type bonds versus those that have features that you may not understand or that do not appear to benefit you.  Before purchasing, you should obtain a complete understanding of all features (i.e. extendable, callable, changes in coupon rates) on bonds and determine how this may impact you as the holder.

Fixed Income 101: Carefully plan debt investments

Fixed income is an asset class that includes short term money market instruments, term deposits, GICs, government bonds, corporate bonds, debentures, and bond funds.  All of these investments are considered “debt” investments rather than “equity” investments.

When buying debt investments an investor is essentially lending money to the issuer of the bond.  For example, a company that needs to raise money generally has two ways to do so – issue stock in the open market or borrow.  By issuing a bond, the company is promising to repay money at maturity, along with, interest.

When purchasing fixed-income investments there are several things you should consider:  credit quality, liquidity, yield-to-maturity, term-to-maturity, and expected income stream of the investments.  The following five questions provide a framework to assist you in evaluating the relative merits of a particular investment.

1. What will my return be?

In order to determine how much you will earn on your fixed income investment, you generally need to consider two things: the coupon of the bond, and the overall yield.     The coupon is the percentage of the bond’s face value that you will receive as income on a periodic basis.  Most bonds pay coupons twice a year.  Yield (called yield to maturity for bonds) is often the more important number to review as it allows bonds of different coupons and maturities to be compared to each other.  Yield to maturity is the total return, made up of interest and repayment of principal that you will receive if you hold the bond to maturity.

2. When will I get my money back?

Most fixed-income investments are issued for a specific period, such as five years, and have a set maturity date.  This is the date on which the face value or principal amount of your investment will be repaid by the issuer, or borrower.

3. How safe is my investment?

You should always check what type of security or guarantee is behind your investment.  Most bonds are not backed by specific assets, but are backed by the full faith of the issuing company.  An investment is considered to be extremely safe and have high credit quality when there is little likelihood that the issuing government or corporation will default on interest payments or not repay your principal.  Bond rating agencies provide investors with information to assist them in gauging the credit quality of their investments.  Lower quality companies will have a higher likelihood of not paying out and therefore be rated lower.  Lower quality bonds will offer a higher yield to attract investors.  Remember higher risk, usually means higher return.  Higher quality bonds, with little chance of default such as Government of Canada, have a lower yield.  You should choose a balance of risk and return that meets your tolerance level.

4. Why is the price changing on my bonds?

Before investing in bonds, you should be aware of any potential volatility that could affect the value.  GICs are an example of a type of fixed income investment that do not fluctuate in value.  However, regular bond prices are affected by moves in interest rates, and therefore prevailing yield in the marketplace.  Bonds prices move inversely to the prevailing interest rates.  As rates go up, bond prices come down and vice versa.  Generally, if a bond has a coupon that is larger than the prevailing yield in the market, the bond will trade above 100.00, considered a premium.  Conversely if the coupon the bond is lower than the prevailing yield in the market, the bond will trade below 100.00, considered a discount.

Bond prices are more likely to remain stable when they are high quality, more liquid and have a shorter term-to-maturity.  Changes in the price of bonds can present different opportunities for active investors.  However, if you plan to hold a bond investment until its maturity, you will receive its face value, therefore, market volatility will not be a factor (provided no default).

5. Can I sell my fixed income easily?

Although you may intend to hold a fixed income investment until maturity, you should still obtain an understanding of its liquidity.  Circumstances may change and you may require cash.  Some fixed income investments are extremely liquid which means that you can sell them easily before they mature.

If you sell a bond between periods of receiving coupon interest you will receive from the purchaser the accrued interest you have earned up to that date.  Less liquid bonds may be harder to sell in the secondary market.  GICs are different than bonds when it comes to selling.  Cashable GICs should not be redeemed within 30 days.

Early redemptions generally result in a loss of interest.   Cashable GICs are usually classified as cash equivalents rather than “fixed income” because of their liquidity and short duration (one year or less).  As for non cashable GICs, investors may be able to find a market to sell.  It is not advisable to buy GICs if you know you may need the money

Balanced investments show success

One of the first discussions we have with new clients relates to risk, which is often associated with equity investing.

Fixed income investments such as term deposits, guaranteed investment certificates and bonds are usually considered lower risk.

Most investors over the age of 40 should have a portion of their investments in fixed income as their time horizon is shorter.  However, the downside to having too much fixed income is the limited return potential in today’s market environment.  Cash and fixed income ensure capital preservation while the equity component provides increased growth potential.

The key to having “peace of mind” as an investor, is to have the appropriate balance that reflects your risk tolerance.  This balance is also known as your asset allocation.

Asset allocation classes include cash equivalents, fixed income, Canadian equities, US equities, International equities and real estate.  Let’s look at Jack Jones and the steps taken prior to choosing individuals investments.

Step 1 involves determining an asset allocation that best matches Jack’s risk and return expectations.  Here’s an example of his optimal asset allocation:

Cash Equivalents 5%

Fixed Income 30%

Equities – CDN 35%

Equities – US  10%

Equities – International 15%

Real Estate 5%

A person who is more conservative than Jack may want to increase the cash equivalents and fixed income component while decreasing equities.  What we find is that many do-it-yourself investors take an all or none approach to a specific asset class.  This means they may end up with either a 100 per cent equity portfolio or all of their money in GICs.   Portfolios that are 100 per cent invested in equities generally are more volatile, and hold greater risk of decline.  However, those who invest entirely in GICs may find it frustrating as yields are generally much lower.  In addition, for non-registered accounts interest income is fully taxable.  After tax is paid, it may be difficult for GIC investors to gain wealth after inflation is factored in.

Simply put, most investors should have a balanced portfolio that can weather different market cycles.

After the optimal percentages are determined above, Step 2 is to establish acceptable ranges as follows:

Cash Equivalents 0-10%

Fixed Income  25-35%

Equities – CDN 30-40%

Equities – US 5-15%

Equities – International 10-20%

Real Estate 0-10%

In a bull market cycle investors may find that the equity component of their investments may increase above the optimal amount noted above.  If the value of the equity class exceeds the acceptable range then a disciplined investment approach should involve rebalancing to the optimal percentages in Step 1.

This rebalancing is Step 3.  Selling equities and adding to fixed income and cash equivalents essentially shifts a portion of your profits to a lower risk asset class.

We encourage investors to stick to their long-term plan.  As fixed income securities mature, we should replace those investments with other fixed income options.

What happens in a bear market cycle?  Investors may find that the fixed income component as a percentage of their total investments increases as equity markets decline.  As noted above a disciplined approach to investing involves rebalancing.  It is possible that this process may involve allocating some of the proceeds from matured fixed income to purchasing equities.  This would only occur if equity markets have declined significantly.

Periodic rebalancing creates the discipline to sell a portion of your equity investments when times are good.  The cash equivalents and fixed income components should also be viewed as a potential source to purchase equity investments when the opportunity arises.

Borrowing to boost your RRSP

Some points to consider when using loans to augment savings

The maximum RRSP deduction limit has increased to $20,000 in 2008.  Those with an income of $111,111 or greater may qualify for this upper limit.  Members of a defined benefit pension plan will have to factor in any current and past pension adjustments.   Most people have salaries below this amount and often it is not easy to maximize annual contributions to an RRSP.

As the deadline for RRSP season approaches many investors may be asking if they should borrow to invest in their RRSP.  The answer really depends on your financial situation.  If you are contemplating borrowing to make an RRSP contribution we recommend you consider these following points:

Taxable Income

The greater an individual’s taxable income the more it makes senses to maximize RRSP contributions.  Reducing your tax liability is often a motivating factor for many individuals when making an RRSP contribution.  Those in the higher marginal income tax bracket should speak with their advisor.  Even if you do not have the cash on hand to make an RRSP contribution it may make sense to borrow the funds to make a contribution by February 29th.

Future Income

Individuals who are considered “employees” may receive a relatively stable monthly income that is predictable from year to year.  Business owners and entrepreneurs generally have fluctuating income resulting in a higher tax bracket one year and a lower tax bracket in another.  RRSP contributions may provide a unique way to smooth your taxable income.  Individuals may have one time spikes in income from selling a real estate investment or other type of investment that generates a significant capital gain.  Planning to utilize a portion of your RRSP contribution room to offset this future liability may make sense.

Term of the Loan

Interest rates are currently relatively low making borrowing for an RRSP fairly attractive.  Most financial institutions provide RRSP loans; however, the rates can vary considerably.  The better the terms of the loan the more attractive borrowing becomes.  Some individuals may choose to utilize their lines of credit, which may have favourable rates and the greater flexibility for repayment.  Business owners may want to utilize an RRSP loan rather than their lines of credit, which have been set up for emergencies.

Length of Loan

The general rule-of-thumb is that the quicker you pay back the RRSP loan the more advantageous it is.  Short-term loans of less than a year may have minimal interest costs and may assist those with fluctuating income.  The more difficult question is when do larger, longer-term loans make sense?  Long-term loans are often used to catch up on a significant amount of unused contribution room.  With longer-term loans it is even more important to weigh the other factors in this article.

Carry Forward Room

Prior to 1991, individuals lost their RRSP deduction room if they did not fully utilize it in a given year.  The good news is that unused RRSP contribution room may now be carried forward indefinitely and includes any unused RRSP deduction room accumulated after 1990.  The bad news is that if you wait too long then you’re missing the biggest benefit of an RRSP – the compounding growth that may occur on a tax deferred basis.  Regardless of the timing, we encourage most individuals to utilize their carry forward room prior to retirement.

Interest Costs

Interest on a loan for your RRSP is not tax deductible. However, money borrowed to earn non-registered investment income may be deductible. This is why it may make sense to use extra cash to contribute to your RRSP and borrowed funds for non-registered investments.  If you have non-registered investments and are considering an RRSP loan you should meet with your accountant first.  There may be a way you can arrange your finances to ensure that more interest costs are deductible.

Return on Investment

This is perhaps the most difficult component for people to analyze.  If you knew with certainty the investment returns you would obtain then the decision may be easier.  Let’s step back and disregard how your investments may perform in the near term.  An RRSP is normally established with a long-term time horizon.  The focus should be on picking the highest quality investments that will prevail in the long run, regardless of market volatility.  We understand that many people scramble to make a last minute contribution to their RRSP.  This is okay provided care is taken when making the investment decision.  If the energy is focused on picking the best investments and the best advisor, then an RRSP loan may make sense.

Simple Strategy

Last year we highlighted a simple strategy that investors could adopt to ease the cash flow burden of trying to come up with their RRSP contribution limit every tax season.  Let’s consider an investor with a $20,000 RRSP contribution limit for the upcoming year.  For this investor we recommend multiplying their RRSP deduction limit by 75 per cent and dividing by 12 to obtain the monthly pre-authorized contribution amount of $1,250.  In either January or February of the following year, the investor could utilize their line of credit or obtain a short term RRSP loan to contribute another $5,000 to top up to the maximum.  After filing the tax return, the combined RRSP contributions of $20,000 may provide enough of a tax refund to pay off the short-term loan or line of credit.  This of course assumes that sufficient tax was withheld on other sources of income throughout the year.

The above strategy is a combination of “automatic” savings by paying yourself monthly and a “forced” short-term loan strategy that creates the discipline to pay off the loan as soon as possible.  This combination has worked well for many successful investors.

Deducting contributions will require strategy

Confusion often results between the terms “RRSP deduction limit” and “unused RRSP contributions.”  Both of these terms are used on the RRSP Deduction Limit Statement at the bottom of your Notice of Assessment from Revenue Canada.

Yesterday, our column dealt specifically with the term RRSP deduction limit.  This column outlines how the unused RRSP contributions is integrated with RRSP deduction limit.

Most investors who contribute to an RRSP claim the deduction immediately on their tax return.  Investors should understand that they do not have to claim the deduction immediately.  In some cases it is recommended that you do not claim the deduction immediately.  If you carry forward an amount it is referred to as “unused RRSP contributions.”

Why would you contribute to an RRSP and not claim the deduction immediately?  The main reason is to shelter the income from tax.  Once you have made the contribution into an RRSP all income generated within is deferred regardless if you have claimed the deduction.  Two other main reasons why you may not claim a deduction immediately are the contribution exceeds current year taxable income, and future income is expected to be higher.

We have provided three illustrations below with different situations where a person may have unused RRSP contributions at the end of the year.


Mr. Bloomberg recently received a significant inheritance of $200,000 from his mother who passed away.  Mr. Bloomberg came to see us and asked for our recommendations.  Prior to our meeting we asked Mr. Bloomberg to gather some information together including his mortgage statement and 2006 tax Notice of Assessment.  We noted that Mr. Bloomberg had $78,000 left on his mortgage with a very small penalty for prepayment.  We recommended that Mr. Bloomberg repay this debt.  Next we looked at his Notice of Assessment and noted that he had a $79,754 RRSP deduction limit.   Mr. Bloomberg is earning approximately $58,000 per year, but over the years, he has not been maximizing his RRSP contributions.  Mr. Bloomberg expects to work for at least another five years and believes that his income will increase over current levels.

Based on the information gathered we recommended that Mr. Bloomberg contribute $79,754 to his RRSP.  Based on his current level of income Mr. Bloomberg should speak with his accountant and determine how much of this contribution he should claim in the current year and how much he should carry forward as unused RRSP contributions.


Mrs. Thomson recently became a widow at the age of 55.  Her deceased husband had a life insurance policy with a death benefit of $250,000.  Mrs. Thomson mentioned that she has no debt and approximately $77,300 in RRSP deduction limit.  Mrs. Thomson is planning to work another ten years and has expected income during this period of approximately $50,000 a year.

We recommended that Mrs. Thomson shelter $77,300 from tax immediately.  However, we also recommended that she claim the deduction over the next few working years.  At the beginning of every year we would encourage Mrs. Thomson to roll some of the remaining non-registered funds to top up her RRSP.  Based on $50,000 a year, she will have another $9,000 each year in additional RRSP room.  She may also want to take advantage of the $2,000 excess contribution that CRA allows over the deduction limit.


Over the last 20 years Mr. Reuter has worked hard as a realtor.  His knowledge and expertise has been in real estate and he has focused nearly all of his investments in that area.  Mr. Reuter has never contributed to his RRSP and has an RRSP deduction limit of $143,600.  Mr. Reuter is now in the process of selling one of his rental properties.  We have estimated that his taxable capital gain on this property will be approximately $33,800 and the total proceeds will be approximately $389,000.

We explained to Mr. Reuter that contributions to an RRSP may offset the taxable capital gains.  We also provided Mr. Reuter some information on alternative investments that he could focus on outside of real estate.  We recommended that he could use a portion of the proceeds from the rental property and contribute $143,600 to his RRSP.  He could deduct enough to reduce the capital gains tax and his real estate income in the current year.  The remainder of the contribution he may carry forward as “unused RRSP contributions” to offset against future rental properties that he sells and his real estate commissions.

Excess Contributions

When you have an unused RRSP contribution amount it is important that you monitor this amount along with the RRSP deduction limit line.  Be careful that the unused amount does not exceed your deduction limit by more than the $2,000 buffer that CRA allows.

If the unused amount exceeds the deduction limit amount by more than $2,000 then you have made what is referred to as an excess contribution.  Excess contributions are subject to a one per cent tax on the excess amount for every month they are left in the RRSP.  If you have excess contributions, you may have to complete and send a T1-OVP return with payment to your tax centre no later than 90 days after the end of the year in which the unused contributions exist.  Failure to file this return may result in further interest and penalties.   We would encourage all investors who have an excess contribution to proactively deal with their mistake before CRA sends you a letter.

Understanding RRSP terminology and your existing tax situation may ensure that you take full benefits of your options, including when to deduct your RRSP contributions.

RRSP deduction limit has value

Registered Retirement Savings Plans have been around since 1957, allowing investors to sav for their retirement while providing a shelter on tax.

One of the most significant legislation overhauls to RRSP legislation was in 1991 with the carry forward provision.  Now investors no longer have to make a “use it or lose it” decision.

The provision allowed unused RRSP contribution limits after 1990 to be carried forward.  The RRSP deduction limit is included on your Notice of Assessment that Canada Renue Agency sends after you file an income tax return.

Your RRSP deduction limit may be carried forward indefinitely.  This is an important component for everyone to note, considering most people have incomes that increase over time.

Consider Mr. Samson, who is 25 years old and has been a professional student for much of his life.  He decided in 2006 to start working and earned $40,000.  In 2007, Mr. Samson’s RRSP deduction limit is $7,200 ($40,000 x 18 per cent).  Mr. Samson feels that he will be making a larger salary soon and would rather dedicate his current year earnings to paying off his student loans.  He does not lose the $7,200 RRSP deduction limit.  Every year that he does not contribute to an RRSP he will be accumulating a greater deduction limit to be used in the future.  If his income increases then he may save more in taxes by delaying his RRSP contribution.

Marketing by financial institutions may be one reason people rush out and make last minute contributions.  It may also be recent news question whether Canada Pension Plan and Old Age Security will exist when they retire.  Or perhaps it is some internal fear of having enough to live on at retirement that pressures so many into making RRSP mistakes.

Check your Notice of Assessment and your deduction limit before you make any contributions.  You should understand what each line represents.  If you are a member of a defined benefit plan then your statement will have pension adjustments.  If you are a member of a defined contribution plan you should factor in contributions made through work.

The sum of both of these contributions should be factored in prior to making any additional RRSP contributions.  Care should be taken to ensure that you do not contribute over your deduction limit.  Canada Revenue Agency provides a buffer of $2,000 before an excess contribution is subject to tax.

Here’s another illustration to make the point:

For nearly 20 years Mr. Phillip has focused his after tax savings to paying down his mortgage.  At 50, he is proud that he is mortgage free.  Mr. Phillip has managed to accumulate approximately $97,200 of RRSP deduction limit.  Now that he is mortgage free he would like to accelerate his retirement savings but does not know where to begin.  Mr. Phillips annual income is $85,000 and he has been dedicating approximately $1,500 a month towards mortgage payments.  Annually Mr. Phillip’s RRSP contribution room is increasing by approximately $15,300 (18 per cent x $85,000).   We discussed with Mr. Phillips that since he no longer has to make monthly mortgage payments, he should consider making monthly pre-authorized contributions to his RRSP.   We mapped out a plan that he could contribute $1,950 monthly to his RRSP, claim the amount as a deduction and save taxes.  The net amount would likely be close to his previous monthly mortgage payment of $1,500.  Best of all, by age 61, Mr. Phillip should have caught up and fully utilized his RRSP deduction limit.

Contribute Early

Time has an amazing way of compounding investment returns.  Investors who begin contributing early to their RRSP are more likely to be financially prepared for their retirement years.  The sooner people begin investing; the longer the savings will be able to grow on a tax sheltered basis.  Tax deferred compounding over a larger number of years should naturally result in a greater accumulation of funds.  One benefit to waiting later in the year to contribute is the greater certainty you will have regarding your income levels and your actual deduction limit.

Avoid Mistakes

If a person pulls funds out of an RRSP, they do not recover the deduction limit.  This amount is lost.  Clearly understanding that your RRSP deduction limit will not vanish if not used should ease some financial pressures.

An RRSP should generally be set up to fund your retirement and involves a long-term discipline.  If you feel that you will likely have to make a withdrawal then you should consider waiting until you are confident that the funds are committed until retirement.  We would rather see someone miss out on a little bit of time to ensure they are not making the mistakes that some people make.


The top 10 mistakes made with RRSPs

A Registered Retirement Savings Plan is not for everyone, but for those who are considering RRSPs or have them, it pays to head off some of the most  common mistakes.

Prior to setting up an RRSP, determine whether you are likely to make one of the following 10 common mistakes:

1.  Often people rush to make a last-minute RRSP contribution and give little thought to the underlying investment.  Spend a few minutes to remember how long it took you to earn that money and slow the selection process down.  Solution:  If you are in a rush we recommend that you consider making contributions to your RRSP in cash and look at all your available investment options prior to making an investment decision.

2.  Over contributing to your RRSP may result in T1-OVP penalties and interest.  This past year we noted a campaign by Canada Revenue Agency that resulted in several letters being sent to individuals who have made over-contributions.  Solution:  Before you contribute to your RRSP, be certain of your limit.

3.  Making contributions to an RRSP and pulling the money out before retirement.  Often this results in more tax being paid than what you initially saved as a deduction.  The shorter the time period between the contribution and withdrawal, the less likely you are to have received tax deferment of income.  Contributing funds and withdrawing the funds uses up your contribution room, which is a big negative.  Solution:   Avoid contributing to an RRSP unless you can commit the funds until retirement.

4.  People who have an RRSP account should understand that all income generated in the account is tax deferred.  This is by far the biggest advantage of an RRSP.  Over time, this should save you much more in taxes than the initial deduction for the contribution.  People who have non-registered investments understand that income generated in these accounts is taxable.  Pulling funds out of an RRSP prior to age 72 is generally the wrong decision when non-registered funds are available.  There are some exceptions, such as shortened life expectancy.  Solution:  Using the capital within your non-registered investments first will reduce your current annual income and defer taxes further.

5.  Some people have multiple RRSP accounts held at different financial institutions.  They may have $10,000 at institution A from a 2004 RRSP contribution, $6,000 at RRSP institution B from a 2005 RRSP contribution, and $8,000 at institution C from a 2006 RRSP contribution.  This may result in additional RRSP fees being charged to you and result in you paying more fees than you need to pay.  More importantly, your investments become more difficult to manage.  Solution:  Consolidate your RRSP accounts at one institution for better management, to reduce fees, and to open up more investment options.

6.  Underestimating life expectancy is also a common mistake.  All too often people in their 60’s begin pulling money out of their RRSP solely to avoid paying a large tax bill if they were to pass away.  We encourage people to plan for the most likely outcome rather than the worst-case scenario.  Solution:  Avoid early withdrawals and ensure that you take full advantage of the deferral benefits of your RRSP.

7.  When you open an RRSP account you must make a beneficiary selection.  If you are married or living common law then the natural choice is your spouse for the tax-free rollover provisions on the first passing.  Often widows will still have their deceased spouses named as beneficiary.  We have seen cases where people have remarried and have their ex-spouse still listed as a beneficiary.  In some cases naming your estate may be the best option.  Solution:  Speak with your advisor and ensure you have the correct beneficiary on your RRSP account.

8.  We encourage people to give careful thought to the type of investments they hold within their RRSP and outside of their RRSP.  Good structure decisions are important and are easier when all of your investments are at one institution.  To illustrate this we will use an individual that has equity investments within their RRSP that may generate dividend income and future capital gains (all income within an RRSP is treated as regular income for withdrawals).  Let’s also assume that this same individual has GICs and term deposits at the bank that are not within their RRSP.  Although this individual does not require income, he is being taxed every year on the income.  Solution:  Have interest generating investments within your RRSP along with equities that you may trade from time to time.  Outside your RRSP consider investments that are long term holds that generate primarily capital gains.  For non-registered accounts, Canadians are not taxed on unrealized gains until the investment is sold.  If you purchased a basket of blue chip equities outside of your RRSP and held them for 20 years you would not be taxed on the gain until the investment is sold.  In effect you have created two types of tax deferred plans.

9.  People who do not have pension income (not including CPP and OAS) should ensure that they are taking all planning components into consideration before requesting early RRSP withdrawals.  Withdrawals from an RRSP are not eligible for the pension income amount and they are not eligible for income splitting.  Solution:  If you require funds then we encourage you to wait until at least age 65 and then convert funds to a RRIF before withdrawal.  RRIF income received at age 65 or older may be eligible to be split and qualify for the pension income tax credit ($2,000 each per year).

10.  One of the biggest mistakes we see is failure to make an RRSP contribution.  Individuals who are making large salaries without a pension need to take advantage of their RRSP contribution room.  Not having the discipline to set aside funds for retirement will result in making sacrifices at retirement.  Solution:  Consider making an RRSP contribution.

Locked-in plans require careful thought

Employees who retire, terminate their employment early, or find their pension plan being discontinued need to make some important decisions.  Some pension plans are being closed and employees have the “lump sum” or “annuity” option.  Other people are faced with a difficult choice, which we discussed in our last article.  Do you take a lump sum of money from the pension today, purchase an annuity, or wait to receive a monthly cheque at retirement?

The lump sum option allows the fully vested (owned) pension benefits to be transferred to a locked-in registered plan.  This article focuses on lump sum transfers to locked-in accounts.

So, what is a locked-in account?  This type of investment account is registered and is one where the plan issuer signs an agreement with your employer to “lock-in” your pension plan proceeds until retirement.  A lump sum from your pension plan is transferred into the registered locked-in investment account.  The age at which the funds may be released, and to what uses they may be put, vary with the pension legislation governing the plan.  Any amounts earned by the plan also become locked-in.

Withdrawals are generally not allowed from Locked-in Registered Savings Plans (LRSP) or Locked-In Retirement Accounts (LIRA), except in limited circumstances such as shortened life expectancy, small balance or financial hardship.  The governing legislation controls these funds, even though the employee can invest them as they wish (similar to an RRSP).  Some provinces have been changing their legislation with respect to locked-in accounts.

Governing Jurisdiction

Knowing the jurisdiction of your pension will assist your financial advisor in setting up the correct account.  In B.C., locked-in accounts are generally referred to as Locked-in Registered Savings Plans (LRSP).  In Alberta, Saskatchewan, Manitoba, Quebec, New Brunswick, Ontario, Newfoundland, and Nova Scotia these accounts are referred to as Locked-In Retirement Accounts (LIRA).

Company pension plans in Canada can be established and registered under either provincial or federal legislation. The legislation governing an individual’s funds must be established upon opening the locked-in plan, as this will determine what type of plan will be opened. The pension plan administrator or the financial institution transferring the funds should provide the information necessary to correctly identify the jurisdiction governing the funds.

Provincially Regulated Pension Plans

Most pension plans are established under provincial legislation. For all provinces and territories except Quebec, the province in which the client resides on the date they terminate employment determines the governing jurisdiction, which may in fact differ from the jurisdiction in which the company is registered.

For example, a person living in Ontario the day they terminate their employment will have their funds under Ontario jurisdiction. Even if this person moves to British Columbia and transfers their pension funds, the client must open a LIRA (the name for a locked-in plan for Ontario) and not an LRSP because the funds are still under Ontario jurisdiction.

Federally Regulated Pension Plans

For federally regulated pension plans, the person’s governing jurisdiction is Canada regardless of place of residence. This applies for crown corporations or companies under federal charter.  A person living in Alberta (which offers LIRAs) who has federally regulated funds will be required to open an LRSP, since federally regulated funds require LRSPs and not LIRAs.

Maturity Options

The earliest age in which you may transfer your LRSP or LIRA into an income account (LRIF or LIF) varies by province. The governing jurisdiction also dictates the minimum age when a client can transfer their locked-in funds.  Similar to an RRSP, locked-in accounts must be converted into an “income account” or a life annuity in the year individuals turn 69.   The 2007 Federal budget proposes to extend this conversion to when the taxpayer reaches the age of 71.


The minimum and maximum withdrawal amount will fluctuate from year to year and is based on the year-end value.  The year-to-year amount will vary depending on the amount of money you withdraw, the income your plan earned and any market fluctuations that may occur.  A LRIF/LIF is similar to a RRIF in that the holder is required to receive a minimum payment out of the plan each year.  The minimum payment levels are calculated using the same method used for RRIF payments.  Additionally, these accounts are subjected to a maximum withdrawal limit. The maximum amount is established by a formula, which takes into account a discount factor and the person’s age.

In the first year an LRIF/LIF is opened, there is no minimum withdrawal required; however there is still a maximum allowable payment. This maximum is pro-rated for the number of months, including the month of transfer into the plan that is remaining in the year.

Transfer Process

Moving from a Registered Pension Plan to a locked-in plan is usually straightforward.  The first step begins with opening a self-directed locked-in registered account.  The institution name and account number will be required to complete the forms provided by your employer.  Typical forms may include a cover letter with the estimated pension value, Canada Revenue Agency forms (i.e. T2151 for direct transfer and T2037 for purchase of annuity) and a locked-in agreement.  Your investment advisor should be able to assist you with completing these forms in conjunction with setting up the appropriate account.

Cash Transfer

Lump sum pension transfers to a locked-in account generally take two to four weeks and come in as cash.  During the transfer period we recommend that individuals meet with their advisor and begin planning their investment portfolio.  For many people a lump sum transfer from their registered pension plan represents the most significant portion of their retirement savings.

Before making a final decision we recommend that you speak with your professional advisors.


You’ll need a plan in order to live on investments

We recommend anyone requiring income from their investments to establish a plan.

An important component of that plan is to ensure income is transferred from a client’s investment account to their banking account.

Although investment firms still issue manual cheques, the number of transactions executed electronically is rising rapidly as investors are becoming more comfortable trusting the electronic transfer of funds from one account to another.  With electronic transfers, there is no risk of mail being lost and transactions are done in a timely manner.  When transfers are done on a scheduled basis they are referred to as a systematic withdrawal plan – often referred to as a SWIP.

A financial institution usually requests a void cheque from the investor’s banking account to obtain the institution, transit and account numbers.  SWIPS are set up to electronically transfer a predetermined amount from an investment to a banking account.  Understanding the income currently being generated from the investments, maturity dates, and liquidity of the portfolio are key components to look at when setting up an appropriate SWIP.

Investors have flexibility with respect to the amount of income they would like to receive and when they would like to receive it.  The following illustrations provide an overview of how SWIPs are often used.

Illustration 1:  Mr. Jackson requires a high level of income from his portfolio. He has requested we send him all of the income from his investment account on the first of every month.  Mr. Jackson has $200,000 invested generating approximately $12,000 per year in income.  We provided Mr. Jackson with an expected income report and noted that his monthly income ranges from $600 to $2,000; however, his average income is approximately $1,000 a month.  For the month of September he earned $740 investment income.  This amount will automatically be transferred to his investment account on the first of October.

Illustration 2:  Mrs. Reynolds has several investments that generate income.  She has a mixture of common shares, preferred shares, convertible debentures, and bonds.  Mrs. Reynolds would like to see her portfolio grow a little further before she begins pulling out all of the income generated.  She has decided to set up a SWIP that automatically transfers the investment income from the income funds to her bank account on the first of every month.  The income from the preferred shares and the bonds will stay in the investment account.  At some point in the future she may increase the SWIP to include all income.

Illustration 3:  Mrs. Walker has a cash flow need of approximately $4,000 per month.  Her sources of income are from CPP, OAS, and a small pension, all of which add up to approximately $2,400 per month.  How is Mrs. Walker going to fund the monthly shortfall of $1,600?  The most obvious place to look is her investments which are currently generating approximately $800 per month; short of the $1,600 she requires monthly expenses.  We explained to Mrs. James how a SWIP can be set up to transfer a flat dollar amount, such as $1,600, even if this amount exceeds the monthly income generated in the account.  We established a plan that allowed for certain investments to be partially or fully liquidated over time to ensure the monthly payments could be sustained during her lifetime.  This included factoring in projected income amounts and maturity dates of her investments.  With this type of SWIP more planning is required.