Basics for
Mike Volker

Start an RRSP!

Contact: Mike Volker, Tel:(604)644-1926, Email: mike@volker.org


An RRSP is the best program offered by the Canadian government to allow people to shelter income in a "tax haven" to allow them to save for retirement (and other) purposes. RRSP means "Registered Retirement Savings Plan". (In this article, the word "contribution" is frequently used. Think of this as a special contribution just for you!)

Not only does an RRSP effectively serve as a tax shelter, but it also allows you to deduct contributions made to it from your taxable income, thereby reducing your taxes payable. So, in essence, you are investing money that you might otherwise be paying as taxes into an RRSP. What a deal! And, any interest payments which you might make on money borrowed to put into an RRSP are unfortunately not deductible on your tax return, but there may be a way of effecting this. For example, if you have to borrow money, make sure that you arrange your finances such that you always borrow for non-RRSP investments. These borrowings are then deductible. In other words, don't put your disposable cash into non-RRSP deals. Put this cash into the RRSP and borrow to make other investments. If you haven't done so, you may be able to gradually "re-arrange" your affairs towards this end.

Here's the point: if you invest $1000 per year over 30 years at a modest return on investment of only 10%, your $30,000 in cash will be worth $180,000 (at 15% it would grow to $500,000). But, if you invest the same amount in a non-RRSP account in which you get paid 10% interest per year, and assuming you are in the 50% tax bracket, you would only have less than $60,000 after 30 years (i.e. only twice your cumulative cash investment). You can be a millionaire in 30 years by investing less than $3,000 per year in an RRSP which returns only 12%!! Outside of an RRSP, it would take you over 50 years to achieve the same goal.

People often don't put money into an RRSP because they don't have the "spare" cash. In this case, the knowledgeable person would borrow (all banks will loan you money to put into an RRSP account with them) funds to start an RRSP. The reader is challenged to figure out the tax benefits of this - i.e. deduction of your contribution, deduction of future interest payments, and the tax-free compounding within the RRSP.

You do not pay taxes on any RRSP money until you actually start to withdraw funds from an RRSP. At that time you are taxed as if these funds were ordinary income. That in itself, may be beneficial if you withdraw funds during a year when your income is down (e.g. if unemployed for a period of time). You can withdraw funds anytime. The only "catch" to an RRSP is that you are limited to how much you can put in in any given year (maximum is going up to $18K as announced in the Feb, 2003 budget). The actual amount is determined by taking a percentage (18%) of your previous year's income. If you elect not to make the maximum allowable contribution, you can carry forward the unused contribution amounts indefinitely, although you will miss out on letting your capital grow tax-free. As for the tax deductibility of contributions, it should be noted that you do not have to use the tax deduction in the year in which you contributed. The tax deduction may, in fact, be claimed in later years (very useful when you are first starting out and have little or no income taxes to pay). Make the maximum annual contribution for maximum benefit.



It's easy. Just set one up. The easiest is at a bank (the bank will loan you the money to put into it and the interest on this loan is tax-deductible). As you become more sophisticated, you can set one (or more) up at a brokerage firm as a self-administered plan. Remember an RRSP is nothing more than an "account" with a certain label attached to it.


If you think that you are too young or just a student and ought not to worry about such matters, think again! You might also think that you cannot afford to put any money into an RRSP even though you are allowed to. Think again. The fact is, that you can borrow (regardless of your credit rating!) money to put into an RRSP account. For example a bank will lend you money at, say 8%, to put into an RRSP account at that same bank. The bank would then invest the RRSP money (the RRSP is the collateral for the bank's loan to you) in a safe, interest-bearing account. Even if the RRSP only earns 4%, let's say, you are still ahead because you are building up the equity in your RRSP and all that equity grows without you having to pay any taxes on it year after year (i.e. for 10-30 years, whereas the loan you took out will be repaid in a few years' time). Of course, it is unlikely that you'd only realize a 4% return when there are many low-risk higher return securities available (e.g. mutual funds, GICs, etc). Initially, the difference between the interest you pay to borrow your RRSP contribution and the interest earned in the RRSP is offset by the taxes you save by making the RRSP contribution. Plus - later on, when you do start to generate some real income, you'll be able to pay off those bank loans and you'll already be on your way to a nice little nest egg.

The rule of thumb with RRSPs is to invest the maximum permissible amount each year - no matter what. Go for it!


Now that you have an RRSP set up, what should you invest in? First of all, there are two types of RRSP accounts: self-administered and pre-defined. In the case of self-administered RRSPs, you make all the investment decisions for the account. You can invest in high risk penny stocks or you can invest in high grade government bonds - it's up to you. One word of caution: if you invest in risky securities, you may erode your RRSP asset base. You cannot claim losses within your RRSP against other income. Therefore, you should make speculative investments outside of your RRSP. On the other hand, if you make a speculative investment inside an RRSP, any gains realized will not be taxed - a tough decision! Since you are the manager of a self-directed RRSP, you will have to learn about your investment options and the inherent risks and rewards. In bull markets such as we have seen in the 1990's, it is easy for money managers (you included) to show good returns. But, beware - the bulls don't always charge. One nice thing about a self-directed RRSP is that you could use it to invest in such things as mortgages - including a mortgage on your own home! Or, you could set up several such RRSP accounts at various brokerage houses. You might use one for blue chips, another one for penny stocks, and so on.

In the case of a pre-defined RRSP, the managers of the RRSP define the types of investment (e.g. high tech mutual funds, real estate, government bond, etc.) which that particular RRSP will make. Usually, the managers of the RRSP (often banks or investment dealers) will be able to provide you with a history of their performance over a number of years. Look carefully at the long term returns. After all, RRSPs are generally intended for their long term benefits. In bull markets, you may find that an RRSP manager has been able to show 5-year average returns of 25%, but show only 15% over a 20 year period. Basically, you are allowing a professional investment manager make the investment decision for you and you have to look closely at their demonstrated track record. Shop around. Listen, learn, and then make a decision. Don't be in a hurry to make investments. Set up the RRSP even if you don't know how it is going to be managed. You can learn that as you go.


Each year, when I explain this concept to students, they tend to be skeptical and not convinced. I suppose that's due to us being conditioned into thinking that if the government designed it, there must be a catch. By establishing such a program, the government benefits because old age security problems are lessened, i.e. people have their own retirement income without relying on or worrying about getting government pensions. Some people may also think that the government uses are has access to savings in RRSP accounts. This is simply untrue (unless you, via your RRSP, invest in some form government securities).

Some people think that, just because they are in a low tax bracket, they needn't bother contributing to an RRSP. I suppose that if these people never plan on getting into a higher tax bracket and don't have any plans to invest or save, then they have a point.

It bears repeating that there are two main reasons to invest, the most important one being the sheltering of future income from taxes. The sooner your money starts to grow in a sheltered account, the less you have to worry about future taxes. The second reason relates to the tax deductibility component. Certainly, if you are in a taxable position, it makes sense to reduce your taxes. For lower income earners, like students, there may not be an immediate tax-reduction benefit. However, you can carry forward this tax deduction benefit until you can use it. In the meantime, however, you can still put some money into an RRSP and get the compounding and capital accumulation started right away. And there's one other very important, perhaps psychological, aspect to consider. If you save or invest in non-RRSP accounts, there may be a greater temptation to draw from those accounts. There is more of a "barrier" in taking money out of an RRSP, effectively ensuring that you are not depleting your future nest-egg. Also, at the  beginning, the benefits (both the tax deduction and the tax-free accumulation) of having an RRSP may not be readily apparent. Often, people think that this may be a "small way to avoid taxes". But, if you understand the time value of money and compounding, you'll see that over a 30 year period, you can easily triple or quadruple the value of your savings!

Make no mistake about it, though. If you should reap a windfall profit in a sheltered account, wouldn't it be nice to re-invest that without paying more than half of it in taxes? Have you ever wondered about that saying, "the rich get richer"? The "rich" know the value of sheltering income and deferring or avoiding (not evading!) taxes. I know may people with 7-figure RRSP accounts and they just keep on getting bigger.

Finally, if you're still not convinced, look at it this way: what have you got to lose by giving it a try?


It's not a good idea to put just any type of investment in an RRSP. Often, it isn't a simple matter to determine what should be put into an RRSP. For example, if you buy shares in a high-risk company and these become worthless, then you've reduced the amount in your RRSP that you have for retirement as well as the growth potential of that lost capital. On the other hand, because you've been able to deduct the original contribution amount from your taxable income, you get a better tax break than if had invested outside the RRSP and taken a capital loss. Let's look at the reverse case where you invest, via your RRSP, in a stock that grows substantially, say from $10,000 to $100,000. In this case you pay no tax until you start to take money out of your RRSP. When you do this, you pay tax at your full rate, likely over >40%. On the other hand, if you made the gain outside of the RRSP, you'd pay the capital gains rate and you'd pay only half as much tax. But then again, by having the full $100,000 in the RRSP, the entire amount can be re-invested and continue to grow tax-free until you start taking it out. As you can see, there are always pros and cons to consider and what works best for one person may not be the solution for another! (Note - when capital gains rates where much higher, it made more sense to shelter huge gains in an RRSP.)


In 2001, 6.2 million Canadian tax filers contributed just over $28.4 billion to their RRSPs. The median contribution in 2001 was $2,600. 83% of tax filers had "contribution room", i.e. they could have contributed more if they wished to. In dollar terms, the $28.4 billion that was contributed is only 9% of the $316 billion that was available to tax payers! In 1999, 55% of families had RRSPs, almost double the percentage from 1984. In 1999, the median value of RRSPs was $20,000 whereas the average size was $51,200.  


This article is targeted mainly at professionals, i.e. professional engineers who are expected to be above-average wage earners. Individuals who are in the lower income brackets may not enjoy the same benefits as those in higher brackets, e.g. tax deductions, and an RRSP may not be as useful to them. Having said that, it might still be a way for lower income earners to "force" them to save for the future.


Banks offer lots of brochures and booklets on this subject as do brokers, accountants, and of course - Revenue Canada. No personal finance book is complete unless it touches on this subject! In the post-Christmas period from January to March, you will find a wealth of information - advertisements, stories, etc. because contributions made during this period can actually be deducted on the prior year's income tax return!

There are many web sites which will give you more information on RRSPs. A sampling of these is as follows:

Copyright 1995 - 2008 Michael C. Volker
Email:mike@volker.org - Comments and suggestions will be appreciated!
Updated: 2008-01-28

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