Balance Junkie » Retirement

You’re Young. The Economy is Bad. Time to Invest in the Stock Market?

2 Cents — Thu, 13 Oct 2011 09:45:02 +0000

The following is a guest post. Please go ahead and share your own thoughts in the comments section.

The current recession and bear market has created difficulties and decisions for private investors across the board, but reactions are slightly different depending on one’s age. Older investors have been switching over to safer investments, such as bonds and CDs. Middle age investors, reaching the peak of their earning potential, have sought to diversify their portfolio while riding the recession out. But what about younger investors? I’m talking about those people who are in their twenties or thirties, have only recently moved into stable jobs, and have limited investments in the market – if they have any at all. Should this demographic start investing now, when the market is low? Or should they wait until the economy is healthier before putting their money in?

Someone in that age range should start by considering their long-term savings, family, and retirement plans. If they need help figuring it all out, they can consult a wealth manager or online resources like retirement calculator.com. Then, they want to decide whether to invest now or later.

Reasons to Invest in the Market Now

People often say that a bear market is the best time to buy, and they have a good point. Although the declining stock value of many companies is a sign that these firms are really struggling, there are many others out there who have been undervalued and are just as strong as ever. If you do some research and invest wisely, there’s no reason why you shouldn’t get a good return on that investment, especially over the course of several decades. After all, recession or not, history certainly suggests that a stock portfolio should increase in value over time. If you are investing now at age 30 and plan to let that money sit for the next 25 years, there’s a high chance you won’t be too disappointed.

Reasons to Wait

But there are several reasons for why you, as a young investor-to-be, might want to do things differently. First of all, even if the market does grow predictably over the course of decades, signs of a double dip recession suggest that it might be a few more years before any real gains are seen. Or, at the very least, the current economic mood will likely dissuade any speculative bubbles in the near future, meaning that the market can be expected to flatline for a while before climbing steadily.

If you are young, and have no investments in the market thus far, it may be beneficial to wait a few years, since it’s hard to imagine that you’ll miss out on any big gains in the meantime. But, of course, at this stage in your life, you certainly want to start saving and investing. Instead of putting a lump sum into the stock market, though, or having to monitor stocks in order to make periodic contributions, it might be best to regularly set aside money for a 401k, money market, or CD. In a couple of years, once you have some retirement accounts established, you can then look to the stock market.

With these considerations in mind, you can now examine your personal savings goals and arrive at a conclusion. If you do things right, there are few bad times to start investing. But make sure that you’re investing wisely.

Safe Retirement Withdrawal Rates and Probable Outcomes

2 Cents — Fri, 25 Feb 2011 10:45:07 +0000

[Ed Easterling of Crestmont Research] favors us with yet another book, called Probable Outcomes: Secular Stock Market Insights, in which he takes on the mostly silly research, done by so many analysts, that purports to show what an investor can expect to make from his retirement portfolio over time. I can’t tell you how disastrous this simplistic analysis can be for retirees.

~ John Mauldin

Update: This article was included in the Wealth Builder Carnival #30 at Wealth Builder as well as the Carnival of Financial Planning #174 hosted by The Financial Blogger. Thanks!

I’ve got some Friday Food for Thought for you this week that fits in nicely with our recent discussion on passive investing and the dangers of investment dogma. It comes to us courtesy of John Mauldin’s most recent installment of Outside the Box. This edition, entitled Stay Out of the ROOM, shares an excerpt from Ed Easterling’s latest book. The book is called Probable Outcomes: Secular Stock Market Insights. ROOM is an acronym for Run Out Of Money.

As you’ve likely deduced from the opening quote, the book deals with retirement planning assumptions. Of course, the whole idea of retirement planning is to decrease the probability (hopefully to zero) that you will run out of money once you’ve stopped working. Mr. Mauldin’s take: “I can’t recommend this book strongly enough. If you are retiring or thinking about doing so and think you can safely take 5% a year, please, please read this book.”

Secular Cycles Matter

I’ve mentioned before that one of the issues with a purely passive approach to investing is the failure to consider the effects of secular cycles on the distribution of returns throughout your wealth accumulation years. If you happened to sock away the bulk of your wealth during a secular bear market like the one from 1966 to 1981 or the current cycle that began in 2000, your returns are likely to be adversely affected compared to those who were able to invest during a secular bull market like the one from 1982 to 1999.

Undoubtedly, your individual results would depend on when and how you invested your money, and might be somewhat smoothed out by dollar cost averaging and rebalancing. Still, Ed Easterling raises 4 key points on the effects of secular cycles and the distribution of returns:

Secular stock market cycles deliver returns in chunks, not streams.
Most investors live long enough to have the relevant investment period extend across both secular bulls and secular bears.
Investors do not get to pick which type of cycle comes first.
Investors need to be aware that they will likely encounter both types of cycles.

Awareness is the key here. It pays to remember that when the secular bear occurs in your investment time line will affect your results. If it occurs when you’re doing the bulk of your investing, or shortly before or after you retire, you may not hit the targets that “historical returns” say you should achieve.

Safe Withdrawal Rates and Reasonable Assumptions

Safe Withdrawal Rates (SWRs) are becoming more important than ever these days as the last surviving spouse can expect to live well past ninety. If you retire at age 60, you may have over 30 years of retirement living to fund. Many variables will determine how much you need to save, so you’ll inevitably have to develop some basic assumptions about expected returns, tax rates, longevity, inflation, and a host of other variables.

Mr. Easterling can explain his position on these assumptions best:

“Some advisors or planners will go so far as to advocate that today’s long-term retirees invest heavily in the stock market. Those pundits say, “A market that has never lost money over thirty-year periods won’t let you down in the future.” It’s true that there has never been a thirty-year period when stock market investors overall have lost money, yet there have been quite a few thirty-year periods that have bankrupted senior citizens who were relying upon their stock portfolios for retirement income.

Most analysts and models suggest that a retiree can withdraw 4% to 5% of the original balance each year, increased annually to cover inflation, and still have a very good chance of not running out of money. The models, however, often do not use reasonable assumptions and do not sufficiently consider risk. Generally, such high withdrawal rates relate to investment portfolios that are significantly weighted toward stocks, especially during the current and recent environment of low bond returns.“

So what are the chances of avoiding the ROOM scenario? Easterling points out that most models use historical average returns, but that “average rarely happens.” Market returns are usually well above or below average. Using historical average returns since 1900, there is a 95% success rate, meaning the last surviving spouse doesn’t run out of money 95% of the time. But what if your returns don’t match the historical average?

Valuation Matters

During secular bear markets, P/E (price to earnings) ratios tend to decline. So although the stock market may move higher, lower, or stay the same, valuations tend to come down. Mr. Easterling presents data that shows that the P/E level at retirement has a significant impact on the success rate for retirees:

“For retirees who are primarily invested in the stock market, the most significant factor determining future returns is the level of valuation at the time of initial investment, as measured by the P/E ratio.”

So while the success rate for the entire group was 95%, those who entered retirement with a portfolio of stocks when the P/E was 18.7 or higher only had an expected success rate of 76% based on historical data. But those who started with stocks at lower P/E levels and 4% withdrawal rates had a 100% success rate. Using 5% withdrawal rates, the average success rate was 75%, with a range of 41% to 100%. Again, these stats are based on historical data, so your returns and probability of success will depend on your own time line and how it matches up with the secular market cycles and valuations.

The Bottom Line

There’s a lot more data in the article, so I would recommend that you read the whole thing if you’re interested in a more detailed analysis. Or better yet, get the book. I haven’t read it yet, but I’m going to add it to my list.

Here’s how Ed Easterling sums up the challenges facing those of us who are trying to figure out how much we need to set aside for retirement:

“There is no magic solution, no one way to achieve success. Given that retirees over this decade and longer are confronting the conditions of a secular bear market, it is important to start with a reasonable expectation about future returns and market conditions, then to apply appropriate investment strategies and approaches. Early personal planning and ongoing investment discipline can help toward avoiding the ROOM.“

Secular bear markets have lasted anywhere from 16 to 21 years in the past. If the current one began in 2000, we could be in for some more choppy years. Having said that, if you are in your 20s right now, you may just be putting away the bulk of your retirement savings during the next secular bull market, and that could increase your odds of success. Those of us who are a bit older may want to treat stocks a little more cautiously for a little bit longer.

What’s your take on influence of secular stock market cycles on retirement savings?

5 Reasons to Skip the RRSP Contribution this Year

2 Cents — Mon, 24 Jan 2011 10:45:56 +0000

The conventional view serves to protect us from the painful job of thinking.

~J.K. Galbraith

Update: This article was included in the Canadian Personal Finance and Investing Carnival #14. Thanks!

January is already coming to a close and February will soon be upon us. In the Canadian financial realm, that usually means a mad dash by financial advisors and journalists to remind us that we only have a few weeks left to make the obligatory contribution to our RRSP, or face the reality of dining on Tender Vittles in our golden years. This year, however, there seems to be a bit of an RRSP backlash, with more than one article taking a not-so-fast tone to contrast the steady “RRSP now” drumbeat pounded out by some members of the financial services industry and media.

Recently, Jon Chevreau of the Financial Post reviewed a report by CIBC Wealth’s vice president of tax and estate planning, Jamie Golombek. The report said that some Canadians may be too quick to jump into the RRSP instead of a TFSA (Tax Free Savings Account) because of the up-front tax refund. Many forget that we still need to pay taxes on that RRSP money when we withdraw it, and that it will be included in our income at the time. That can result in clawbacks to government benefits like GIS (Guaranteed Income Supplement) or and OAS (Old Age Security).

So maxing out your RRSP contribution may not always be the best course of action. To be sure, it’s a great idea if you happened to have a very high income in the past year, or if you received some kind of one-time bonus or windfall. But it’s not always the optimal choice, especially since the introduction of the TFSA.

The Most Important RRSP Question

For me, the number one question to ask yourself before you put money into an RRSP is the following:

What is the likelihood that you will pay less tax on that money when you withdraw it than you would now?

If it’s likely your tax rate will be lower when you take the money out, then by all means, contribute some cash. But if you’re pretty certain your tax rate might be about the same or higher, then it makes more sense to invest that money outside an RRSP.

5 Reasons to Skip the RRSP Contribution this Year

There are several reasons why you might want to temporarily exit the RRSP highway this year:

1. You’re in Debt

If you have credit card debt, it’s probably costing you about 20% a year in interest. You’re better off paying off that debt first.
If you’ve taken on a little more house than you can afford, you might be concerned that a rise in interest rates might make your mortgage unaffordable. Why not pay down the mortgage instead of contributing to you RRSP? It provides a guaranteed, tax-free return at your mortgage rate.
If you have a car loan, consider the interest you’re paying. Would it make more sense to pay off the car?
If you had higher income last year and you really want to take advantage of the tax refund an RRSP contribution will provide, go ahead and make the contribution, but make sure you apply the refund to your debt.

2. You’re Young

If you’re in your 20′s or even your 30′s or 40′s, there’s no way of knowing what the tax laws will look like when the time comes to withdraw money from your RRSP. What if the tax rates are even higher then?
Rules surrounding RRSPs and retirement could change by the time you retire.
You probably have a lower income if you’re just getting started. In that case, it makes more sense to max out your TFSA contribution room and pay down debt first.

3. Lower Income

Perhaps you’re income wasn’t that high last year. In that case, it’s better to save your contributions for a time when your income is higher.
If you’re concerned about losing your job or you’re in sales or self-employed and you had a slow year, you may want to put your savings for the year outside an RRSP in order to have better access to the money in case you need it. (If you needed to withdraw the money from an RRSP, you would have to pay tax on that money.)

4. You Have TFSA Contribution Room Available

If you have some TFSA contribution room left, you may want to max that out first and then put the remainder in an RRSP, depending on some of the other factors mentioned here.
Money earned in a TFSA is completely tax free when you withdraw it, and it has no effect on income-tested government programs like GIS and OAS.

5. You Already Have a Lot of Money in Your RRSP

Obviously, you shouldn’t contribute more than the amount allowed by your RRSP contribution limit.
If you have a good chunk of change in your RRSP and you’ll also be receiving a substantial pension in retirement, it’s probably a good idea to take a look at the tax implications. If your tax bill is going to be very heavy in retirement, it might be time to lighten up on the RRSP contributions and consider some non-registered investments or savings products.

If you’d like another take on this, Jim Yih recently wrote a great article on The New Debate Between RRSPs vs. TFSAs.

Are you contributing to your RRSP this year, or taking a break to focus on other priorities?

(Photo Credit: ARENA Creative)

Get Your Inheritance Early – And Other Ways Your Parents Can Save Thousands in Taxes in Retirement

2 Cents — Mon, 16 Aug 2010 09:45:05 +0000

The following is a guest post by Frank Wiginton CFP, FMA, CIM, FCSI.

I want to start off by saying that I am not advocating anything that could get you put away! What I am recommending is that you speak with your parents about saving them thousands in taxes throughout retirement. Those who are in retirement may be paying too much in taxes on money they will never use!

The big question most people in retirement have is “Will I run out of money?” There is a great calculator on the home page of my website at www.frankwiginton.ca that will tell you whether you will run out of money, and if not, how much you will still have left as an estate. It will also tell you approximately what your lifetime tax bill will be. You will likely be surprised by the numbers – many are!

So now that you know your parents won’t run out of money and they are likely to be leaving a sizable estate and paying a hefty tax bill what should they do with the money?

Watch a video of Frank discussing some of these idea’s on BNN!

Spend It!

Once your parents have done proper comprehensive financial planning and they can conservatively estimate that they will have lots on money left over, start spending it! The problem with this very simple solution is that many who have saved during their entire life struggle to flip the switch from saver to spender! There is a great article from the National Post a few years back where Ted Rechtshaffen, CEO of TriDelta Financial discusses this issue.

I say go out and live your life! Do the things you want to do while you can! Too many times have I met people who have saved all their lives putting trips and time with family and buying a dream cottage or car on hold; just to be stricken with an illness at a time when they are ready to start doing and enjoying these things.

Shelter It!

TFSA – If they have excess assets that they really aren’t going to use, maximizing the use of the new Tax Free Savings Accounts (TFSA) is a good place to start. Naming a beneficiary on these accounts will also ensure this money passes to the beneficiary tax and probate free. If they eventually plan for this money to go to you, their children, through their estate, it may make sense for them to deposit money into TFSA accounts and shelter more of their assets! Technically the assets will legally become yours and you could withdraw them at any time.

Insurance Policies – Rather than hold investment assets that go up and down with the market and increase your parents annual tax liability through capital gains, interest, and dividend income – they could purchase a life insurance policy. Example: Let’s say Mom is 64 years old and in fairly good health. She could purchase a permanent life policy for $11,500 a year which upon her death will pay out $500,000 tax free to her beneficiary! So instead of having that $11,500 generate investment tax liabilities every year for the rest of their life it will be sheltered (in the form of premium on an insurance policy) with a principal guarantee and guaranteed to generate a return (the return will depend on how long they live). Now this won’t work for everyone as there are several factors and qualifiers. Here is a great article talking about this concept!

Personal Real Estate – Your parents may have already paid off their mortgage and can only claim one personal residence for tax exemption purposes. So how can they use real estate to shelter assets? Again – if they plan to leave money to their children, they can start paying off the children’s mortgage! Right now with interest rates so low there is little benefit to do this. But, rather than sticking money that won’t be used into a five year GIC at between 2-3% and having that income taxed – why not pay down the kids mortgage that is running at 4%+! When mortgage rates do eventually start to rise they will have a lot less mortgage to renew at the higher rates!

Give It Away!

A simple idea is for your parents to give money now to the people they want to have it. They not only get to see them enjoy the money while they are alive they also save the tax on the future growth. If your parents are giving it to minor (under 18) they need to be aware of the potential income attribution rules of the taxation. My recommendation is to give it to the parent with direction that it is for the minor. That way the growth is taxed in the parent’s hands and not the grandparents’. NOTE: when you are gifting securities you can choose to gift the asset at the book value (what you paid for it) or the current market value or some value in between. If you gift it to the child at the market value you will have deemed to have disposed of the asset and if the value is higher than the book value you will end up with a capital gain and have to pay tax.

Consider contributing to the grandchildren’s RESP to help pay for college. This sheltering will also qualify them for the Canada Education Savings Grant (20% bonus up to $500 a year).

Donate It!

This is a whole article in of itself! Donating assets to a favourite charity has many tax benefits. The 40% tax credit is a great start with cash donations but this can easily climb to 60 or 80% depending how you donate other assets to the charity! Donate securities and you avoid the capital gains tax. Donate insurance policies and you could claim the annual premiums as charitable donations. There are many other ways to donate to charity depending on your overall financial situation.

To learn how much you could afford to donate to charity every year try the TriDelta Financial Donation Planner. It is a very simple tool that will show you how much you might be able to afford to donate!

In order to do tax planning in retirement properly and effectively you need to start with a comprehensive financial plan. From this you will substantially reduce your investment risk and develop a clear picture of the different factors that influence your taxable income. From understanding the taxation of various investment assets, to drawing down registered assets early, to income splitting, and tax sheltering; you can start to truly plan an effective tax reduction strategy. Without the comprehensive financial plan you will end up paying tens of thousands of dollars more in taxes throughout your life.

Frank Wiginton is a highly sought after personal finance speaker and a Certified Financial Planner with TriDelta Financial. Over the past eleven years Frank has made it his mission to improve the lives of others by providing independent, unbiased, financial advice. He works with clients to prepare comprehensive financial plans that give them a better quality of life.

Frank is routinely asked by the media to comment on personal finance issues. Appearing on Business News Network (BNN), CITYTV, Global TV, and heard on CBC radio and quoted in the Globe and Mail, National Post, Toronto Star, MACLEANS, Canadian Business, Chatelaine, and Money Sense Magazine.

He is a Certified Financial Planner (CFP), Financial Management Advisor (FMA), Canadian Investment Manager (CIM), and a Fellow of the Canadian Securities Institute (FCSI).

A passionate sailor, traveler, photographer, and outdoorsman, Frank lives and works in the Toronto area with his wife and daughter.

frank@wiginton.ca www.frankwiginton.ca Twitter: @1frankthought

Variable Returns Can Work Against You in Retirement

2 Cents — Wed, 11 Aug 2010 09:45:08 +0000

The following is a guest post by Jim Yih, a fee-only advisor, best-selling author, financial expert, and syndicated columnist. Currently, Jim specializes in putting financial education programs into the workplace. For more information you can visit his websites at Retire Happy or Wealth Web Gurus.

Variable Returns Create Timing Risk

One of the problems of return projections in the financial industry is that most of the math is modeled on a straight line. For example, the math on a 7% average return really assumes that you make 7% per year each and every year. If you think about it, the rate of return is really the slope between 2 points – a start point and an end point. If you had a 9% return, the slope would be steeper. If you had a 5% return, the line would be flatter.

If you had $100,000 and you took out $9000 per year (assuming no inflation and a 7% average return), the math on a straight line would say that you would run out of money in 20 years.

The problem, of course, is the investment portfolio never moves in a straight line. It moves with peaks and valleys and every now and then it crosses the straight line.

Chart #1

Would the outcome be different if the math was done using the black line instead of the red line? Let’s take a look.

Stronger Returns Early in Retirement

Let’s assume a set of hypothetical, variable returns over a 25 year period where retirement starts in a bull market with some positive returns right off the bat. As you can see from the chart, the sequence of returns averages out to the same 7%. The start point and the end point are the same but it just takes a different path to get there. This sequence of returns allows the money to last the entire 25 year period and still have some money left at the end. This sequence of returns has the $100,000 lasting more than 5 years longer largely because a couple of strong returns in the first couple of years extends the longevity of the portfolio.

If a couple of good years has a positive effect on the longevity of the portfolio, do you think a couple of bad years might affect it too?

Weaker Returns Early in Retirement

Chart #2

In this next set of numbers, we look at variable returns but we reverse the order of returns so instead of starting with a couple of good years, we start with a couple of bad years.

Remember, because the returns are exactly the same, the average return does not change. Now, with the case of bad timing, the portfolio only lasts 12 years, which is 13 years earlier than if the portfolio started with good years. That’s a huge difference in results.

As you can see, success is clearly a case of timing.

Will You Retire in Good Times or in Bad Times?

Although this example is hypothetical, the experience is real. Do you know people who have delayed retirement because of the stock market? Do you know people that have retired but gone back to work because of what the stock market has done to their portfolio? Do you know people who have cut back on their lifestyle in retirement which is supposed to be the golden years because of drops in their portfolios?

This has happened far too often and the lesson is simple. As you get closer to retirement, you need to re-evaluate your portfolios and make them more conservative. Part of your portfolio needs to be guaranteed and not exposed to the variable, unpredictable returns of the stock market. I’ve played with these numbers a lot and the end result is always the same. The more risk and variability you have in the portfolio, the bigger the disparity of outcome. The higher the withdrawal rate, the bigger the risk of running out of money.

Variable returns can work against you. The market risk that is supposed to reward you can sometimes work against you especially in retirement when you are drawing an income from your investments. The math is real so remember that investing IN retirement is very different than investing FOR retirement.

RRSPs: Taking Money Out

2 Cents — Thu, 28 Jan 2010 10:45:28 +0000

Life is not long, and too much of it must not pass in idle deliberation how it shall be spent.

~ Samuel Johnson

Our series on RRSP Basics continues today with some information on how and when to take money out of your RRSP.

Withdrawing Money Before You Retire

The idea behind RRSPs is that you won’t be taking any money out until you retire. But as we all know, life happens. Here’s how it works if you encounter an emergency where you absolutely need to take some of your money out:

Any money you take out of your RRSP will be added to your income at your marginal tax rate in the year you withdraw it.
Your withdrawal will be subject to a withholding tax which will be deducted by your financial institution. The withholding rates for Canadian residents are as follows:
- 10% (5% in Quebec) on amounts up to $5000
- 20% (10% in Quebec) on amounts above $5000 up to $15000
- 30% (15% in Quebec) on amounts above $15000

*Note that you will eventually still be responsible for paying tax on your withdrawal at your marginal rate, whether that is higher or lower than the amount of withholding tax you are charged.

If you withdraw money from a spousal RRSP, it will be taxed in the hands of the contributor if he/she made contributions to any spousal RRSP in the year of withdrawal or either of the 2 previous years. Otherwise, the withdrawal will be taxed in the hands of the annuitant (the receiving spouse). The money can generally only be withdrawn by the annuitant.
When you withdraw money from an RRSP, you do not get that contribution room back again.

Withdrawing Money in Retirement

You can continue to contribute to an RRSP up until December 31st of the year in which you turn 71.
You can continue to contribute to a spousal RRSP for your spouse or common law partner until December 31st of the year in which he/she turns 71.

Once you reach the magic age of 71, you have several RRSP options:

Withdraw the money from the RRSP: This money would be subject to withholding tax and taxed at your marginal tax rate in the year of withdrawal as outlined above.
Transfer the money to a Registered Retirement Income Fund (RRIF): If you choose this option, there is no tax on the money you transfer, but you will pay taxes on any money you withdraw or receive from the RRIF.
Use the RRSP money to purchase an annuity for life: Life annuities pay you a prescribed amount each year until you die.
Use the RRSP money to purchase an annuity spread over a certain number of years: Term annuities pay you a prescribed amount each year for a certain period of time.

RRIFs

Starting the year after you set up a RRIF, you receive a minimum amount each year using a formula based on your age and the value of your RRIF. Of course the whole aim of retirement planning is to run out of life before you run out of money. In many ways, this requires that we are able to predict the future. None of us knows the number of days in our lives. We just need to plan based on what we know now and do our best to hedge against all possibilities. There is no way to get it exactly right unless you are clairvoyant.

Have you done the math yet to figure out what your retirement income might look like?

RRSPs: What Should You Put in Them?

2 Cents — Tue, 26 Jan 2010 10:45:39 +0000

The road leading to a goal does not separate you from the destination; it is essentially a part of it.

~ Charles DeLint

Update: This article appears in the Carnival of Personal Finance #242 – Fun Tax Facts at Cash Money Life. Thanks Patrick!

Yesterday we began a series on RRSP Basics with a primer on what an RRSP is and who should use them. Today, we’re going to look at where you can get them, what you can put in them, and how to decide what you should put in them.

There are a few types of RRSPs that you can get:

Basic: These are usually provided through an advisor affiliated with a mutual fund dealer or bank who offers advice on where to invest your money.
Self-Directed: These are plans, usually through discount brokerages, where you choose where to invest your money.
Spousal: One spouse contributes money to an RRSP for the other. The contributing spouse gets the tax break, but the money belongs to the other spouse. In case of divorce, the assets are divided between the spouses just as any others would be.
Group: You may have access to a group RRSP plan through your employer. Some employers will match your contributions up to a certain limit. Your choice of investments depends on the specifics of your plan. Make sure you understand the details of your group plan and figure out how it fits in with your overall investment and retirement strategy.

Where Can You Get Them?

Banks & Trust Companies: You can open an RRSP at any of the big banks or trust companies and they will usually provide you with some advice on how to invest your savings. Be careful, however, if you notice that all of the investments they recommend are affiliated with their bank.
Brokerages: You can opt for a full service or discount brokerage, and most of the big banks offer discount brokerage services as well. Each year the Globe and Mail releases a list of discount brokerage rankings. Your choice will depend on your level of investment knowledge and the way in which you want to allocate and manage your money. If you go with a discount broker rather than a full service outfit, you will likely be choosing a self-directed RRSP.
Financial Advisor: Often advisors are affiliated with a mutual fund dealer and as such will only recommend mutual funds for your RRSP. While this may be a good strategy for you, be aware that you have many other alternatives, some of which may be more appropriate for you. If your advisor isn’t willing to explain them to you, you may want to find a new one.
Credit Unions: If you belong to a credit union, check out the types of RRSP products that they offer. These may include RRSP savings accounts, GICs, mutual funds, and more.
Insurance Companies: Many insurance companies offer RRSPs as part of an overall financial plan. They may offer GICs and mutual funds, but most specialize in annuities.

What Can You Put in Them?

Savings Accounts: If you want the lowest risk, most liquid place to park your RRSP cash, this is the ticket. The only catch is that, while your deposits will likely be CDIC protected up to $100000, you will earn very little interest on your deposits as long as rates remain low as they are now. Some of the banks that offer higher interest savings accounts (like Ally and Canadian Tire Financial) do not offer RRSP versions of their savings accounts. ING Direct and PC Financial do offer high interest savings accounts under the RRSP umbrella, but ING Direct currently has the better rates.
GICs: Guaranteed Investment Certificates are also safe, CDIC protected places to invest your RRSP money. They are available in terms that generally range from 90 days to 5 years. You can find shorter or longer terms, but these are the most common ones out there. Usually, the longer you lock up your money, the higher the interest rate you’ll receive. Right now, ING Direct is offering a 3% rate on a 90 Day GIC. This is a great deal, as the 5 year GIC is only paying 3% as well. (Note: I have no affiliation with ING Direct right now. I’m just a satisfied customer.)
Mutual Funds: Mutual funds are groups of equities or bonds (or both) that you can purchase in the form of units. You can usually sign up for monthly contributions or add lump sums to your investment as you like. Beware of fees with these products. Make sure you understand exactly what you are paying for the fund and to your advisor, if you’re using one.
ETFs: These are like mutual funds, only they are usually associated with much lower fees and are more often available through discount brokers rather than advisors.
Stocks: You can include the stocks of individual companies in your RRSP if you use a full service or discount broker.
Bonds: You can buy individual government or corporate bonds through a broker. You can also invest in bonds through mutual funds or ETFs that may represent a variety of bonds linked to a bond index. You can concentrate on corporate or government bond indices individually, or you can buy an ETF or mutual fund that contains a mixture of both.
Options: Options are investment vehicles that are derived from stocks or other financial instruments. They are fairly complicated for the average person and I don’t have enough knowledge in this area to give you a great deal of detail on them. They are, however, RRSP eligible. Still, unless you really know what you’re doing, leave them to the experts.
Your Mortgage: Yes, you can technically hold your own mortgage inside your RRSP. I have read a little about this, and it is usually not recommended, except in a few specific circumstances. It seems pretty complicated and I would again caution against swimming in the deep end of the pool unless you really know what you’re doing.

What Should You Put in Them?

The answer to this question will depend on your unique situation. Generally, your asset allocation will depend on your risk tolerance. The higher your risk tolerance, the larger your concentration on stocks, or mutual funds and ETFs that contain stocks. Bonds are less risky, but not risk-free. GICs and savings accounts contain the least risk. Here are some factors to consider:

Age: Your age will usually determine your retirement time horizon (unless you are a 28 year old whiz kid who is already independently wealthy). Generally, your time horizon will determine how much risk you are able to take in your investments. As you get closer to retirement, you should own fewer stocks, more bonds, more GICs and perhaps a high interest savings account. If you are 10 to 20 years or more from retirement, you can afford to take a little more risk if you like.
Your Other Investments: What other assets do you own? A home? Non-registered stocks, bonds, etc.? You need to make sure you are diversified across all areas of your financial life both inside and outside your RRSP.
Your Unique Personal Situation: Your marital status, the number of children you have, your income level, job stability, and health status are just a few of the factors that might affect how and where you allocate your RRSP dollars. The more risk in your personal situation, the less risk you should take in your investments.
Your Personality: Some people like to take more risks. This can spread to their investments as well and there is nothing wrong with that, so long as they are fully aware of and OK with the level of risk to which they are exposed. Knowledge is power. Always know the maximum that you can lose.

This is meant to be a discussion of RRSPs at a very basic level and it is far from complete. Still, I hope it has you thinking about your retirement plans and how you want to handle them.

What’s your RRSP strategy? How do you decide where to allocate your assets?

RRSPs: Who Needs Them?

2 Cents — Mon, 25 Jan 2010 10:45:39 +0000

Warning: Dates in Calendar are closer than they appear.

~ Author Unknown

Registered Retirement Savings Plans (RRSPs) were introduced by the Government of Canada in 1957 as a means of encouraging Canadians to save for retirement. That need has only grown over the decades as corporate pensions have been cut and the number of companies matching contributions has dwindled.

Many pension plans took a huge hit when the stock market fell in 2008 and 2009. Although they have since recovered a lot of their losses, the crash reminded us that money in the stock market is money at risk.

To make matters worse, Canadians have been saving less, taking on more debt, and keeping that debt on their balance sheets for longer than in the past. In October of 2009, The Globe and Mail ran an excellent series entitled Retirement Lost which outlined many of the issues facing Canadians as we plan for retirement. These are issues that people are grappling with globally. They are issues that are important to our future, but are sometimes hard to find the time to address in the present.

‘Tis the Season

January and February are often the busiest months of the year for RRSP providers as taxpayers rush to decide how much they want, need, or can afford to contribute to their RRSPs for the 2009 tax year before the deadline (March 1, 2010). We will be bombarded by advertisements and maybe calls from our financial advisors warning us that we must contribute the maximum amount that we can to our RRSPs before the deadline. For some of us, this is probably a good idea. For others, maybe not so much. This begins a series of articles on RRSP Basics that will hopefully help remind us what RRSPs are really for – and what to watch out for to make the most of your contributions.

Main Benefits

Tax Deferral: Savings and investments held inside an RRSP are not taxed as income in the year you deposit them. You will not pay taxes on that money until you withdraw it from the RRSP. This means you might receive a refund on your tax return depending on your income situation.
Tax Sheltered Growth: In addition to paying no tax on the money you put in your RRSP, you will not pay taxes on any interest, dividends or capital gains that accrue until you withdraw the money. As a result, some experts recommend that you hold interest paying investments inside your RRSP and those with capital gains outside your RRSP, since interest is taxed more than capital gains.

Should You Save in RRSPs or Not? Michael James on Money did some math for us in a good article that discusses the benefits of tax free compounding.

The Cardinal Rule of RRSPs

If you had to boil down whether or not an RRSP is a good idea for your situation to one basic test, I guess it would be this:

Is your marginal tax rate at the time you put the money into the RRSP greater than it will be when you take it out?

Yes: If you know that the answer to this question will definitely be yes, then putting money into an RRSP is a great way to give yourself a tax break now, save for retirement, and grow your investments tax-free until you are ready to take the money out.
No: If your marginal rate in retirement is going to be less than or equal to what it is now, or if you are consistently in a lower tax bracket, you may want to think a little harder about whether or not it makes sense to contribute to an RRSP. On one hand, you still get the tax break and tax-deferred gains. On the other hand, money you take out of an RRSP will be added to your income. This can lead to clawbacks in other government programs like GIS (Guaranteed Income Supplement) and OAS (Old Age Security). If you fall into this category, TFSAs are the way to go for tax free compounding, and zero clawbacks.
Not Sure: If you live with variable income, or you are just starting out and don’t know where your income might be headed, it may be better to take your decision one year at a time. If you have a high income year, that would be a good time to put some money into an RRSP. But don’t forget that if you have highly variable income, you should have a big, fat, liquid emergency fund before you invest a whole lot in RRSPs. If you are younger and it looks like your career is on a good track, go ahead and get started on your RRSP – as long as you are free of consumer debt. If not, pay off your debt first.

What to Watch Out For

Fees: No matter which vehicle you choose for your RRSP investment, make sure that you are clear on all fees that are involved. Most providers charge a transfer fee anywhere from $25 to $150 or more if you want to to transfer your RRSP to another institution. There are usually some kind of fees inherent in most investments as well. Look at the MER (Management Expense Ratio) of any mutual fund or ETF you buy. Anything over 2% is probably too much, and you should try to get it under 1% if you can. A single percentage point can make a huge difference over a decade or more of investing. Be particularly careful with DSC (Deferred Sales Charge) mutual funds sold through advisors. Make sure you understand exactly how they work.
Content: There are numerous options for where you can put your RRSP money. We will detail some of them tomorrow. But for now, make sure you consider your RRSP investments in the context of your overall financial situation and investment portfolio. Make sure you are diversified across your entire financial landscape.
Marital Status: If you are married and one spouse earns a lot more than the other, it may be wise for the higher income earner to contribute to a Spousal RRSP. The higher earner gets the tax break up front but the money is taxed in the hands of the lower earner upon withdrawal (as long as it’s been in there for at least 3 years). This type of income splitting in retirement is not as big an issue as it used to be since 2007 when the government began to allow some pension splitting between spouses.
Government Rule Changes: All of our RRSP planning is based on the rules set out by the government. They can and do change the rules on us from time to time. Back in 2005, the government removed the foreign content limits on RRSPs, allowing us to invest in more U.S. or other foreign investments if we so choose. It just pays to keep on top of legislative changes that may affect your investment strategy.
Revisit Plans Annually: It’s a good idea review your overall investment strategy at least yearly, monitoring any changes in the above factors that may affect your decisions surrounding retirement planning.

Do you have any questions or insights about RRSPs or retirement savings in general? If so, include them in the comments section or send me an email and I’ll try to address them.