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Investment options within your RRSP

The key word in Registered Retirement Savings Plan is savings.

The government allows Canadians to defer up to 18 per cent of the previous years earned income, up to a maximum of $26,230 for the 2018 tax year.

In order to reach the maximum, earned income would have to equal $145,722 or higher. If you are a member of a pension plan, then the maximum is reduced by a pension adjustment.

After filing your annual tax return, you will receive a Notice of Assessment which has your current year RRSP Deduction Limit Statement.

Once your Deduction Limit is known, you may consider contributing early to an RRSP provided cash flow permits. One way to do this is to immediately use any tax refund, if any, to fund the current year RRSP contribution. If you are maximizing every year, then a single lump sum contribution equal to the amount on your RRSP Deduction Limit Statement may avoid the risk of over-contributing.

If cash flow is limited then setting up a Pre-Authorized Contribution (PAC) on a monthly basis may help you maximize contributions. It is important to adjust the PAC amount annually to adjust to your annual RRSP Deduction Limit. Whether you contribute monthly or by lump sum, it is important that you know your limit and do not over-contribute.

Every year you have to decide how to invest the new contribution. In addition to deciding how to invest the current year contribution, you have to continually manage your existing RRSP holdings to get the best long term results.

We have had discussions with clients new to investing that had mistaken an RRSP as a type of investment. RRSP is a type of account but not a type of investment. The Income Tax Act (ITA) outlines that the RRSP is limited to holding qualified investments, such as cash and deposits, listed securities (on designated stock exchanges), investment funds (i.e. mutual funds), and debt obligations (i.e. GICs, Term Deposits, Canada Savings Bonds). There are several other less common types of investments for RRSP accounts but for purposes of this column I will stick with the most common.

Many people rush into a financial institution to deposit funds primarily to get the RRSP Contribution receipt for tax purposes. Although cash is a qualified investment with RRSP, sitting permanently in cash is not a good long term option as returns would be limited.

Before an RRSP contribution is made you should understand the differences between financial professionals and financial institutions. There are significant differences with financial professionals in the scope of both experience and licencing. Some have worked through various market corrections and others are just starting a new career. Some financial professionals are licensed to sell only insurance products, other are licensed through the Mutual Fund Dealers Association (MFDA) and sell mutual funds. Wealth advisers may be licenced with the Investment Industry Regulatory Organization of Canada (IIROC) and have the ability to sell listed securities and mutual funds. You should ensure that the Wealth Advisor you approach has the licensing appropriate to your needs.

With respect to the wide range of financial institutions, you can choose from virtual/online options, insurance companies, traditional banks, credit unions and mortgage investment corporations. You should first determine what type of investment you would like and also what type of services. Even within traditional banks, you have several options including: self-directed, bank branch, and full service. If someone wants to do their own investing and is comfortable with technology then they can consider the online self-directed platforms. These are also referred to as discount brokerage as they have lower fees as you’re primarily doing the work yourself. Options at the bank branch level are typically term deposits/GIC and mutual funds.

Guaranteed Investment Certificates

Some investors purchase GICs, term deposits, and different types of bonds within an RRSP to manage their investment risk level. These types of investments typically pay interest income that is predicable, and volatility is lower. The primary downside to these investments is the relatively low interest rates and return potential. Short-term debt obligations have low real returns after inflation and taxes are factored in. Long-term debt obligations can be surprisingly volatile especially with changes to interest rates. If capital preservation is the primarily objective and time horizon is short, certain types of debt obligations may be suitable.

Mutual Funds

Mutual funds have been around for more than 90 years and have been a very popular type of investment. The concept of a mutual fund is easy to understand in the sense that it is a group of investors who pool their money together and have it managed by a Portfolio Manager. The first stage is picking a fund that matches your investment objectives and risk tolerance. Once the fund is picked, the portfolio manager makes all the decisions and investor does not need to be involved. Another benefit is that investors can choose to contribute a lump sum to the fund or set up automated pre-authorized contributions every month which makes forced savings easy. For inexperienced investors, or those with smaller amounts to invest, a mutual fund allows you access to a professional money manager. You do need some guidance to ensure you pick a mutual fund(s) with the appropriate asset mix and level of diversification. All of the banks offer a selection of mutual funds.

Listed Securities and Wealth Advisers

Investors that have accumulated significant savings have another option available to them. The full-service wealth division of Canada’s largest banks provide a wide range of investment options, typically for clients with investable assets over certain thresholds (i.e. $250,000, $500,000, $1,000,000). As noted above, wealth advisors are registered with IIROC and are able to purchase a wide selection of investments within an RRSP, including the investments noted above, as well as listed securities. One type of popular listed security is common shares that trade on exchanges such as Toronto Stock Exchange, New York Stock Exchange and Nasdaq.

The greater the size of an investment portfolio, the easier it is to obtain diversification with individual holdings. The benefit of transitioning to individual securities is lowering your cost of investing and having more control over the risk level of the account and each security added. It is easier to diversify your portfolio by sector and geographic exposure. Individual blue chip equities typically generate greater income and provide better transparency.

Avoiding significant mistakes is a key component to the success of an RRSP. Common mistakes we see are being too conservative or too aggressive. Keeping the funds in cash or being too conservative will not result in wealth accumulation after inflation and income tax are factored in. Investing in speculative holdings, unnecessary concentration, and making emotional decisions during periods of volatility are also common mistakes.

Kevin Greenard CPA CA FMA CFP CIM is a portfolio manager and director of wealth management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week in the Times Colonist. Call 250.389.2138.

Part II – RRSP Turns 60: Still a Good Bet for Retirement

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 

This is for information purposes only. It is recommended that individuals consult with their financial advisor before acting on any information contained in this article.  The opinions stated are those of the author and not necessarily those of Scotia Capital Inc. or The Bank of Nova Scotia. ScotiaMcLeod is a division of Scotia Capital Inc., Member Canadian Investor Protection Fund.