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The importance of investing outside your RRSP
By
Jim Middlemiss • Bankrate.com
One of the first considerations investors face is
whether to put their hard-earned money to work inside or outside
a Registered Retirement Savings Plan.
On one hand, an "RRSP is the most tax-effective
retirement planning vehicle out there," says Hal Spelliscy,
an investment adviser at Edward Jones in Kelowna, BC. That's because
money grows tax-free inside an RRSP, and you don't pay tax until
you start withdrawing funds. You also get an upfront tax deduction
for your contribution.
On the other hand, you must pay taxes on any profit
-- be it a capital gain or a dividend -- made on any investment
held outside your RRSP or other registered account. But that isn't
necessarily a bad thing.
The difference between saving inside an RRSP vs. outside
of one is most noticeable over the long term. You can see this for
yourself by using the free RRSP vs. capital gains calculator at
RetireWare.com
, a financial planning software website.
There are so many variables to take into consideration
that it's hard to simply say that one strategy is better than the
other. It depends on factors such as the size of your investment,
your tax rate and the rate of return.
But overall, financial advisers say it's wise to use
a blend of both strategies -- investing inside and outside your
RRSP -- for a number of reasons.
Unregistered accounts good for
short-term saving
One major reason you should invest inside and outside your RRSP
is sheer necessity. "When it comes to saving for retirement
an RRSP ... won't cut it," says Patricia Lovett-Reid, senior
vice-president of TD Waterhouse Canada.
That's because of RRSP contribution limits. Currently,
you must earn $86,000 to qualify for the maximum contribution of
$15,500. Few Canadians earn that much, so high-wage earners who
want to maintain their lifestyle in retirement will have to invest
outside an RRSP, she says.
But it's not just the rich who need to do so. Lovett-Reid
says middle-class Canadians who worry about the pension system buckling
under the weight of baby boomers should also max out their RRSPs
and put some money aside in an unregistered account.
Tom Zaks, an investment adviser at RBC Dominion Securities
in Mississauga, Ont., says an unregistered account is also useful
for household emergency
funds or saving for short- or mid-term needs, such as a car
or a house down payment.
Zaks says another benefit to using an unregistered
account is it helps provides tax-effective income in retirement.
For example, if you withdraw $30,000 from an RRSP
in Ontario, assuming you have no other income, it will generate
a $4,846 tax bill. However, if you take $20,000 from your RRSP and
$10,000 from an unregistered account, you could reduce your tax
bill to as little as $3,200.
Types of investments to put
in a non-RRSP account
Setting up a non-RRSP account is simple. You can usually use the
same firm that holds your RRSP. However, you must open either a
cash account, where you pay for your transactions as you go, or
a margin account, which is essentially a credit account that lets
you leverage your contributions and buy more investments using the
financial institutions' money. It's a higher risk than a simple
cash account, but many investors find it useful.
Once the account is set up, the question becomes what
type of investments should a non-RRSP account hold? That depends
on how much money you have available, your appetite for risk and
how your RRSP is structured.
Individual stocks or equity mutual funds are often
best held outside an RRSP. That's because if they lose money, you
can claim a capital loss and apply it against money that you make
on successful investments, which you can't do in an RRSP.
As well, you are only taxed on 50 percent of the gain
in an unregistered account.
On the other hand, investments that generate interest
income, such as bonds or Guaranteed Income Certificates, are taxed
at the highest amounts, so it's best to hold them inside an RRSP.
Lovett-Reid notes that RRSPs limit investors to 30-percent
foreign content, so an unregistered account is also a good way to
increase your exposure to global companies.
Some products, such as investment trusts or certain
tax-efficient mutual funds, are best held in an unregistered account
in order to avoid double taxation.
Keep your investments diversified
Zaks says it's important to have a blend of fixed-income and equity
investments inside and outside your RRSP. "When looking at
your portfolio, you need to keep all your investments in mind,"
he says.
So you might consider holding 60 percent of your assets
in equities and 40 percent in fixed income. Treat your entire holdings
as one account rather than apply the 60-40 mix to each of them separately.
You also want to be properly diversified and not bet
the farm on one investment. So, when you open your unregistered
account, Spelliscy suggests using mutual funds until you hit the
$100,000 mark, at which point you can diversify into individual
stocks, "if you have the temperament."
One good way to grow a non-registered account is through
dollar-cost averaging, where you invest a set amount each month
-- Zaks suggests 10 percent of your salary -- into a systematic
program that allows you to buy a little bit more of each investment
in the account every month.
Jim Middlemiss is a freelance
writer and lawyer based in Toronto. He's a frequent contributor
to National Post, Investment Executive and Wall Street & Technology.
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