To RRSP or not to RRSP

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					To RRSP or not to RRSP – that is the
I logged in to a popular news website this week, and I was entertained by an animation
of a woman trying to decide whether she should go skiing or contribute to an RRSP.

Not surprisingly, the financial institution sponsoring the ad showed how she could do
both, by setting up an automatic monthly contribution plan.

That's a great idea for people in the accumulation phase of their financial lives. The
RRSP is a great method of accumulating capital that can be drawn upon to produce
income in retirement. It does not create money out of nothing, as the ad might have
suggested, of course. Or does it?

If you are earning $40,000 per year, you paid about 35.5% tax on your last $4,000 of
earnings. If you contribute that $4,000 to an RRSP, you will reduce your taxable income
by $4,000 and reduce your total income tax by 35.5% of that $4,000, or about $1,420.

Once your taxable income is below $36,378, your tax rate reduces to 28.75% in
Manitoba and you'll save $287 for every $1,000 you contribute. If your taxable income
exceeds $65,000 after contribution, then the saving is 39.4%, rising to 43.4% at $72,756
of taxable income.

That's a lot of numbers to throw at you, but the important thing to remember is that using
the RRSP as a savings vehicle harnesses tax dollars to help. (Keep in mind that if your
taxable income is below $10,000, you are likely not paying any tax and will receive no
tax saving for the RRSP contribution.)

The regular monthly plan will work well for 2007, but what about your contribution for
2006? The deadline is March 1 for contributions deductible on your 2006 income tax

If you've been visiting your bank or credit union lately, you may have been offered a loan
or even enough credit to catch up on past unused contributions. This can be a good
idea, but here are some guidelines.

First, make sure that the monthly payments are affordable. Ideally, borrow amounts that
you can pay back in less than a year, and use your tax refund to apply against the loan
and pay it off even faster.

As soon as that's done, immediately start a monthly contribution plan toward next year,
using the monthly loan payment amount and anything else you can afford. Consider
applying to CRA to give your payroll officer permission to withhold less tax on your
paycheques, so that you can get your refund throughout the year. Once that is
approved, you can likely increase your monthly contribution amount.

If you get onto this virtuous circle, you may be maximizing your contributions within two
or three years. If you are serious about becoming financially independent at some point
in the future, that's a great thing to do.
Some people suggest alternatives to the RRSP as a savings vehicle, and I think those
alternatives are worth looking at. However, for most people, the RRSP is the most
practical, efficient and least risky of the alternatives.

Other strategies include borrowing to invest and deducting the interest from your income
tax, instead of the RRSP contribution. If you can afford $4,000 per year in payments,
you can theoretically afford to borrow about $50,000 at 7% and make the payments.
Your interest deduction would be $3,500, but a 10% increase in your investments would
earn $5,000, instead of just $400 on your $4,000 RRSP contribution.

This is called leveraging. The reason it can be called a two-edged sword is that a 10%
decrease in your investment value will also lose you $5,000, more than you have
invested so far.

As long as you have the financial and psychological staying power and you are
committed to a five-year run on the loan and the investments, it can work very well. My
only warning is that every time the stock market has a significant correction, many
people chicken out of such plans and sell low. The resulting loss usually keeps them out
of the investment markets until the next stock market high, when they try again.

As with all investing, make sure you stay within your risk tolerance, and know that there
are almost as many bumps along the investment road as potholes on Winnipeg streets.

I hope you stay warm while you’re planning your approach!

David Christianson is a fee-only financial planner and investment counsel with
Wellington West Total Wealth Management Inc. His column appears Fridays. You
can e-mail him at