A beginner's guide to RRSPs
By Jasmine Miller • Bankrate.com

You can't walk into a bank or turn on the TV during tax time without hearing the words -- Registered Retirement Savings Plan. And even if you only bank online and think cable is evil, pop ups, radio spots, newspaper and magazine ads will get you. RRSPs -- they're everywhere.

So you'd think we'd all know the basics by now but, according to some experts, many investors don't fully understand the ubiquitous RRSP.

"The biggest misconception is that an RRSP is a product in and of itself," says Kimberley Killam Brown, a financial planner with Money Concepts in Saint John, New Brunswick. "They don't understand that the investments in the RRSP can be pretty much anything they would have outside the RRSP."

Kevin Potvin is a financial planner in Ottawa with Potvin Rowland Financial Services Inc., and he sees RRSP ignorance all the time. Most of his clients are young, first-time investors between 20 and 35, "so this is all new to them," he says. "I tell them the RRSP is an umbrella, and under that umbrella you can hold many investments."

So what are they?
RRSPs are the government's way of encouraging Canadians to save for retirement. You sock away money and, in return, get tax deferral on the growth of your investments and an immediate tax deduction for your contribution. Like all government initiatives, the red tape, regulations and rules can seem dense. Here's what you need to know:

Who can contribute
You can contribute 18 percent of your annual earned income, up to a maximum of $15,500, to an RRSP. (That maximum increases to $16,500 for the 2004 tax year.) For the purposes of an RRSP, alimony payments, rental income and other sources of money qualify as earned income, but investment income does not.

Let's say you earn $45,000 a year. You can contribute as much as $8,100 to your RRSP for the 2004 tax year. If you only have $5,000 to contribute to your plan, that leaves $3,100 in unused room that you can carry forward indefinitely.

So, next year, assuming you earn the same salary, you could make your $8,100 contribution and the leftover $3,100 as well. Whatever you contribute is deducted from your taxable income for the current year, resulting in less tax to pay.

Anyone with income can start earning RRSP contribution room by filing a tax return. "That's often why self-employed parents start paying their children to do office work," says Potvin.

Whether it's paper-route pay or babysitting money, if your child files an income tax return for the year, 18 percent of that income becomes RRSP contribution room they can carry forward indefinitely.

While you need to reach the age of majority to open an RRSP (it's a legally binding contract, so minors can't do it), any contribution room is a boon and can be used whenever it is of greatest benefit to your child.

You can also open a spousal RRSP in your partner's name -- the investments grow in his name, but the tax deduction is yours.

Keep in mind that if you earn a pension through work or are part of a deferred profit-sharing plan, the maximum RRSP contribution you can make is reduced by that pension adjustment.

The rules
"People don't understand how RRSPs work other than at tax time they can save them some money," says Brown. "That lack of knowledge doesn't give them the right tools to plan and use the RRSP for retirement as opposed to using it simply to minimize their taxes every year."

Before you decide which investments will go into your RRSP, you should think about your needs and risk tolerance, says Brown. No matter what asset allocation you decide on, any investment is fair game: mutual funds, GICs, segregated funds, stocks, bonds, labour-sponsored funds, income trusts and more.

If you contribute more than your maximum to the plan, you will be penalized 1 percent a month on the amount that is over your limit. The exception: Everyone is allowed a one-time $2,000 over-contribution.

"You won't get a tax credit for it, but it will grow on a tax-deferred basis within the plan," says Potvin. That payment doesn't have to be made as a lump sum; it can be a gradual accumulation as well.

You also have to be careful about how many non-Canadian investments you have in your RRSP, as there is a foreign content limit of 30 percent," says Brown. "But RRSP clone funds have opened that door up much more than it used to."

Getting the money out
The money in an RRSP is yours -- you can take it out whenever you want, but it will cost you. If you make a withdrawal, you pay tax on that money at your marginal rate and will be subject to a withholding tax.

How much the tax winds up being depends on the size of your withdrawal, but if you take out between $5,000 and $15,000, the withholding tax is 20 percent (in Quebec, it is 30 percent).

The exceptions are the Home Buyers' Plan and the Life Long Learning Plan. Under the first plan, you can withdraw as much as $20,000 from your RRSP to buy a house and take as many as 15 years to repay it.

Under the second plan, you can withdraw as much as $20,000 from your RRSP to attend college or university. You have 10 years to repay the funds to your plan.

When you turn 69, you must stop contributing to your RRSP -- with any luck you'll have stopped punching the clock and earning a salary at that point anyway. Then you have options.

You could take the money out as a lump sum, but that defeats the tax-deferral purpose since you'll pay tax on the whole whack. To avoid that hit, you can convert the plan to an annuity or a RRIF and generate a regular income stream from the RRSP investments. And, depending on how it's set up, you may pay far less tax.

Jasmine Miller is a freelance writer in Toronto.