Time to Debunk the RRSP Myths

If you want to save on your 2011 tax bill, today is the deadline to contribute to your registered retirement saving plan. You've probably heard all about it in the media or from that guy at work who thinks he's Warren Buffett. You may also have heard a few interesting twists and some downright untruths. I've compiled a few popular RRSP myths to dispel.

1. You must invest your contribution by the February 29 deadline:

Wrong. You only have to contribute to your RRSP account by the deadline to be able to apply it to your 2011 taxes. You can park it and invest later -- or never invest it for that matter. Even if you contribute after the deadline the contribution can be deducted from your 2012 taxes or future years. Contrary to what some unscrupulous mutual fund sales people may say, you don't have to invest it in mutual funds. Just about anything -- stocks, bonds, options -- is RRSP eligible.

2. Registered retirement savings plans are a tax exemption:

Wrong. RRSPs are tax deferrals and there's a huge difference. An exemption is forever. A deferral means you will have to pay tax at some point in the future. An RRSP is a temporary tax shelter that allows the plan holder to delay paying taxes on contributions until the money is withdrawn. RRSPs are popular because they allow savings to grow tax free until the plan holder is in a lower tax bracket -- normally retirement.

3. You should contribute the maximum allowable amount:

Not always. If the amount is too high, the government could claw back your Old Age Security benefits. Claw-backs can be avoided by income splitting where taxable income is split with a lower-income spouse. There's also a strong argument for young investors to delay making RRSP contributions until they are in their higher income years and the tax savings are bigger. All that contribution space can be carried forward for a later date. Another good reason for not contributing too much is the basic assumption that we will be in a lower tax bracket when the money is withdrawn. Governments are piling up debt at an unprecedented pace and there's no guarantee tax rates won't be higher when the time comes for us to withdraw. Consider diverting some of those savings to a Tax Free Saving Account where returns are entirely tax exempt.

4. You cannot make a withdrawal from your RRSP until you retire:

Not true. Money from an RRSP is available to the plan holder at any time, but it's important to know it will be taxed at the going rate. The government allows exemptions such as the Home Buyer's Plan, where the plan holder and spouse can each borrow up to $20,000 provided the funds have been on deposit at least 90 days. Repayment must begin no more than two years later, with at least 1/15 of the funds paid back each year. The offer is only available to first-time home buyers. The Lifelong Learning Plan also allows investors to withdraw up to $20,000 tax free for full-time training or post-secondary education. The full amount must be paid back within 10 years.

5. There are limits on how many foreign securities are allowed in an RRSP.

Not any more. Last decade Ottawa lifted foreign content limits, yet Canadians remain heavily weighted toward Canadian equities. Expand your horizons. There's a world of opportunity beyond banks and resources.

6. An RRSP can be used to back up a loan.

Wrong. Lending institutions do not consider an RRSP collateral for borrowed money.

7. Interest on RRSP loans is tax deductible.

Sorry -- only interest on non-RRSP investment loans is tax deductible.

8. If a plan holder dies, the proceeds of an RRSP are subject to taxation.

Not if the beneficiary is the surviving spouse and the funds are transferred into his or her RRSP or RRIF. If there is no surviving spouse -- in most cases -- RRSP holdings are taxed on the deceased's final tax return and distributed to whoever is named as the beneficiary or to the holder's estate.

For tips on where to put that RRSP contribution Portfolio Builder speaks with KCM Wealth Management president Adrian Mastracci.

February is Your Money Month on BNN. Don’t miss an episode of BNN’s Portfolio Builder where our experts help you sort through your options for investing. The BNN Portfolio Builder brings you everything you need to know about RRSPs and TFSAs, as well as tips on sorting through mutual funds, ETFs, stocks and bonds.