Banker's View : Why you should invest in RRSP TFSA & RESP

Why the Title ?

• March 2nd 2015 is the last day you can make contributions to your Registered Retirement Savings Plan a.k.a RRSP. 

Why January - February ?

• It is a great idea to contribute to Registered Education Savings Plan aka RESP, Tax Free Savings Account aka TFSA or Registered Retirement Savings Plan aka RRSP in these months. 

Why ?

• Your money will start to grow or will grow more if you invest right at the beginning of the year. So, start earning from day one of 2015.

From my experience in Banking, here is why you should invest in these plans

R.R.S.P

What can it do for you?

1. If you want to save money for the time when you stop working (Retirement Years) 

2. If you plan to buy a home and make a down payment (DPMT) for your first home

3. If you plan to study in the next couple of year

Red "R" Is when you will retire

Lets take a look at point # 1

Savings money for Retirement

Lets make a fictional character : 

Name          Laura Jones 

Age             30 Years 

Income       $42000

Works @    TD Bank 

Laura's employer will withhold a certain percentage of taxes before depositing money in to her bank account. Lets say she worked the whole year at the company and they withheld $10000 in taxes for the whole year. 

Now Laura goes to the accountants place to get her taxes done. She gives a slip to the accountant which she got from TD Bank her employer. This slip is called the T4. The T4 from her employer tells the accountant that she earned a total of $42000 for the whole year(2014) and how much TD Bank withheld in taxes ($10000, mentioned above). 

• Laura also got a bonus of $5000 from her employer. This extra $5000 on top of her income will increase her tax bracket and reduce her tax refund for the year. 

What can Laura do here?

One recommendation is that she can take $5000 bonus and make a contribution in to her RRSP. This will reduce oh which she will pay taxes. When she does make the contribution in to the RRSP this will trigger a higher tax refund or reduce taxes payable. 

Keep in mind that the government wants to tax you on every dollar you earn, therefore, the money she contributed in her RRSP, that generated a higher tax refund will eventually get taxed when you withdraw from the RRSP (because that part of your income was never taxed)

So why would you contribute in the RRSP when the money will eventually get taxed in retirement years?

The main concept of the RRSP is to let the money grow in the RRSP with out getting taxed. It is better to contribute to the RRSP when you have a higher income. This reduces the taxes payable or generates tax refund as we saw with Laura. 

• The higher you earn higher amount of taxes to be paid.
• So if you contribute money in the RRSP your income will not get taxed at the highest tax bracket. You would have reduced your income and thus the calculated income tax based on that. 
• Therefore, it is true that if you earn a higher income, lets say $45000 it is a good idea to contribute in to the RRSP and defer the current taxes. 
• When you retire you will not have as many expenses as when you are young. Lets take a look at some of the expenses you might not have to pay for when you retire: 

• Mortgage 
• Loans
• Credit Card Debts 
• Car Loan 
• Student Loan

• So if you do not have to earn as much to support those expenses in your retirement years, this means that your income will be much lower, and also the taxes you pay. That is the main concept of contributing in to the RRSP. 

Note: Always maximizing your RRSP is not a good idea. Use your TFSA with your RRSP to save money. Another season will come soon. RRSP vs TFSA.

What investment options are available for RRSP?

From my experience working in the financial institutions, client are unclear about what RRSP is and what an investment instrument is.

Here is a little break down...

RRSP TFSA RESP, all these are plans registered with the government. Think each of them as a container in which you can throw in different investments. Here is a picture worth a thousand words. 

As you can see, there are three investment options that you can have in your RRSP. You can start your own RRSP and invest in stocks and bonds your self. 

High interest savings account 

• pays about 1.05% at most financial institutes
• usually fully cashable 
• opportunity cost of having money fully cashable is the low interest rate. 
• I from experience do not recommend this option because it pay next to nothing. Unless you are going to need the money soon 

Guaranteed Investment Certificate - GIC/Term Deposit 

• usually are cashable or non cashable 

• two things are 100% guaranteed as the name suggests 
• the interest rate offered (no fluctuation in the interest rate you get the GIC at)
• principle protection 100% (means you will not lose your money, no fluctuation

• the draw back is that if your GIC is not cashable, you can not take the money out until maturity or when the terms tell you, that you can cash it ( usually every anniversary) 

• Example one, a bank offers 2% return on a 2 year locked in GIC
• 2 year locked in means i can not have the funds until the two years have passed.

• Example two, a bank offers two year Rate Riser, 1st year you get 1.5% 2nd year you get 1.6% 3rd year you get 1.8%, cashable after every anniversary. 
• cashable every anniversary means, after 12 months from the date you got the GC, you can cash it out. 

Mutual Funds/Stocks 

• unlike the GIC's, neither the principle nor the rate is guaranteed
• has fluctuation in your money 
• has management fees
• potentially provide you with a much better return

What is a Mutual Fund?

If you want to understand the concept of mutual funds you will have to use you immigration.

Think of mutual funds as a bag full of different types of candies. When I say candy, it means company stocks

Here is a description of this basket of candies(stocks)

• Imagine 100 different types of candy (stock) in the basket 
• These 100 candies (stocks) are from 50 different countries 
• These 100 candies (stocks) are from different regions from those 50 different countries 

To make these basket of candies (Stocks) there is a worker (fund managers) who find out which candy (stock) is good and which one is not good. So he/she keeps on switching these candies based on any new ones that come out or any changes in the candy (stock) market. 

Now, every one does not like a basket full of candy (stocks) so this employee decided to put in some biscuits (Bonds, TBills etc) in it as well. For example, if you only had a basket full of candies (stocks) your sales will fluctuate a lot based on which month you are in. For example, Valentines day your sales will be very high and not so much thorough most of the months. So you need to add something else in the basket so it gets bought out thought out the whole year. These Biscuits are called the Fixed Income piece in a mutual fund. What these biscuits (Bonds, TBills etc) do for the basket is that it keeps the fluctuation in the sales some what stable.

Bonds are more stable than a stocks. If you compare a chart that has a bond and a stock, you will find that stock tend to fluctuate more than the bonds.

Will carry on next time :)