Despite the ubiquitous RRSP marketing messages, many Canadians do not fully grasp the advantages offered by RRSPs. They have difficulty seeing their RRSPs as anything more than a way to reduce their taxable income and squeeze a tax refund from the government.

As a result, many investors procrastinate until the last minute, then rush to beat the deadline. They make hasty decisions about investing the funds that have gone into their RRSPs, or end up accumulating multiple RRSPs at several financial institutions — all charging administration fees that erode their returns.

As an advisor, you can help steer clients away from common RRSP mistakes and assist them in understanding the income-splitting and investment possibilities that the product offers.

“An RRSP is effectively a personal pension plan and should be approached in much the same way as a professional manager handles a large pension,” says Jim Rogers, chairman of Rogers Group Financial Advisors Ltd. in Vancouver. “RRSPs are designed for retirement, and the funds should be earmarked exclusively for that and invested accordingly. People who make allowable tax-free withdrawals from RRSPs to help provide the down payment on a home or pay for education are actually robbing Peter to pay Paul.” Although the funds may be repaid to the RRSP over a 15-year time frame, he adds, the lost value of many years of compound growth on a large lump-sum withdrawal cannot be retrieved.

Perhaps the biggest mistake of all when it comes to RRSPs is failing to take full advantage of the RRSP room available every year. Less than one-third of people who file tax returns make an RRSP contribution; of those, only a small percentage put in the maximum amount. According to Statistics Canada, the median annual RRSP contribution in Canada is only $2,600; Canadians contribute only 8% of the total amount allowed.

Few people realize the impact of lost time, even if they intend to make up for missed contributions later on. Missing a single $1,000 RRSP contribution at age 29 reduces the value of the RRSP at age 69 by about $15,000, assuming an average annual compound return of 7% during those 40 years.

Clients should also know they don’t have to claim their RRSP deduction in the year the contribution is made. It may be beneficial to contribute to an RRSP this year and get the money working immediately, but defer the deduction until a later year when earned income is expected to be higher. RRSP contributions can be carried forward indefinitely.

A client can also choose to deduct only a portion of an annual RRSP contribution or of a larger catch-up contribution in any given year, if that’s all that’s needed to enter a lower tax bracket. But keep in mind that moving to a lower tax bracket also reduces the tax refund generated by the RRSP contribution.

“The advisor needs to compare the taxes that would have been paid at a higher tax rate with the lower refund a client is getting at the lower tax rate, and decide whether it’s more valuable to claim part of the deduction now or later,” says Debbie Ammeter, vice president of advanced financial planning at Investors Group Inc. in Winnipeg.

As well, spousal RRSPs are poorly understood and underutilized by many clients, but they are a useful tool for tax planning for couples. For example, if one spouse or common-law partner is expecting a healthy pension, RRSP assets can be accumulated in the hands of the other spouse. Clawbacks to old-age security, equivalent to 15% of any post-retirement annual income exceeding $60,000, can often be minimized by spreading a couple’s income more evenly between the two partners.

When balancing future income between two spouses, it’s important to consider all sources of income, as the lower-income spouse may be in line to inherit a large sum or has plans to continue working in retirement.

“If you’re looking at an RRSP as a pension, you should be looking at how much income it’s going to provide for the client down the road and how that income is going to be taxed,” Rogers says. “The key is to do some income forecasting and planning ahead of time. RRSPs can’t be shuffled around like chairs on a ship’s deck, and once the funds are in an RRSP, they can’t be moved from one spouse to another without penalty.”

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Many people are under the false impression that any money put into a spousal RRSP will be lost to them if their marriage ends in divorce. As a result, they miss out on this potential tax-reduction strategy. In fact, the law states that in the event of the dissolution of a marriage, all RRSP assets are considered joint family property and subject to division; it doesn’t matter in whose name the RRSPs are held.

While a taxpayer must wind up any RRSPs in the year in which he or she turns 69,
contributions for a younger spouse can be made to a spousal RRSP until the spouse turns 69, deductible to the contributor.

“Even after 69, people can continue to contribute to spousal RRSPs, assuming they still have earned income,” says Jamie Golombek, vice president of tax and estate planning at AIM Funds Management Inc. in Toronto. “Income would probably come from self-employment, consulting or rental property income. If the spouse is much younger, the couple could take advantage of many years of contributions to a spousal plan.”

Clients should be aware that investment income, pensions, RRIF withdrawals or inheritances are not considered earned income and cannot be used as a basis for spousal plan contributions.

Golombek issues an important reminder to those who are turning 69 and collapsing an RRSP this year: they must make their RRSP contribution before yearend; they do not have the usual 60 days at the beginning of next year to contribute.

Not having the cash in hand is no excuse for missing a contribution, whatever a client’s age. Clients can consider contributing “in kind” by transferring eligible non-registered assets such as stocks, bonds, mutual funds and GICs into an RRSP. Certain holdings are not considered eligible RRSP investments, including real estate, art, antiques, put options, commodities and futures contracts. However, mutual funds investing in such areas as real estate, options and commodities may be eligible and provide useful RRSP diversification.

Also, make sure your clients keep their RRSP beneficiary designations up to date. And when an RRSP is converted to a RRIF, this is considered a new account and the client must rename the beneficiary. If no beneficiary is named for either an RRSP or a RRIF, typically the plans become property of the estate, and taxes will take a big bite. IE