Registered Retirement Savings Plans (RRSPs) were first introduced 60 years ago, created by the federal government to help people who didn’t have a work pension to save for retirement by socking away pre-tax money.
In 1957, the threshold for the RRSP was the lesser of 10 per cent of income or $2,500. Over the years the threshold methodology has changed. Over the years, the threshold methodology has changed. Since 1991, the income threshold of 18 per cent of income has been used.
Starting in 1996, and continuing to today, the new contribution ceilings were indexed to the rise in average wages.
For 2017, the annual maximum, or contribution ceiling, is $26,010, which is reached when earned income is at $144,500 for the prior year. After you file your 2016 tax return, the government communicates to taxpayers their 2017 RRSP contribution limit on the Notice of Assessment.
The calculation for the RRSP contributions limit is adjusted for individuals who have a work pension. This reduction is referred to as a pension adjustment and also shows up on your Notice of Assessment.
A pension adjustment is done for both Defined Benefit Plans, where employers bear the risk of market-value changes, and Defined Contribution Plans, where employees bear the risk.
Pension plans have been deteriorating over the last decade. Individuals who either do not have a pension through work, or do not have a good quality pension, should consider having an RRSP.
Outside of the two types of pensions, some employers will offer a program to help build up your RRSP, or other accounts. In some cases, these are matching type programs, where you can put in a certain percentage of your salary, and your employer will match it, up to a defined threshold. These are often referred to as a group RRSP and it is worth participating in.
If you have an RRSP program at work, then having that one is a must. As you are typically restricted by the types of investments you can invest in with a group plan, we encourage people to also have one external RRSP account.
The external RRSP account would hold all the contributions done outside of your group plan. In some cases, individuals can transfer funds from a group RRSP to an external RRSP. In other cases, the funds must stay in a group RRSP until you cease employment with the sponsoring company.
You should receive a statement for any company sponsored pension. Reviewing this statement is especially important if your plan is a Defined Contribution Plan where you had to make investment choices.
You have made decisions to determine the percentage to invest in fixed income versus equity and whether to have Canadian equities versus foreign equities.
If you have a group RRSP plan, you likely can view information electronically and also receive statements more frequently.
All of this information should be provided to your financial advisor, prior to making any financial decisions regarding your external RRSP.
As the quality of pension plans has deteriorated, the methodology of how to invest funds within an RRSP has changed for some investors. The three broad categories are cash equivalents, fixed income, and equities.
In 1957, a 90 day treasury bill (cash equivalents) could be purchased with an interest rate of 3.78 per cent, climbing to 17.78 per cent in 1981.
Investing RRSPs in conservative investments, such as cash equivalents, provided decent enough returns during this period. The latest T-Bill auction of 2016 had the 90 day treasury bills paying a yield of 0.50 per cent. Most would agree that putting the investments within your RRSP into cash equivalents would not provide the returns to keep pace with inflation, especially after tax is factored in.
Bonds are a type of investment that is classified within fixed income. The reason most investors purchase bonds is for capital preservation and income. In order to achieve the goal of capital preservation, it is advisable to invest in investment-grade bonds. Yields on these bonds are at historic lows. The yield curve is also very flat, so purchasing a longer term investment grade bond does not increase the yield significantly enough to warrant the potential risk if interest rates rise. The primary reason to hold bonds in an RRSP portfolio today is capital preservation.
Equity investments provide both growth and income. In fact, the right types of common shares can pay dividend income that exceeds the interest income on most investment-grade bonds. Portfolio values will fluctuate greater as the equity portion increases.
An advisor can put together a portfolio of lower risk stocks, often referred to as “low beta” that can reduce this volatility. We feel those who tolerate increased volatility will be rewarded in the long run by holding the right equity investments.
Kevin Greenard CPA CA FMA CFP CIM is a Portfolio Manager and Director, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week in the TC. Call 250.389.2138. greenardgroup.com