What RRSP should I buy? - Originally published in

David - it is late but what should I buy for my RRSP this year.
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david ingram replies:  The following was originally published in Resource World Magazine in February 2004. Nuff said!!
 
A client recently came to the office with a self-directed RRSP to which he had contributed $1,000 of a highly speculative Resource stock that he hoped would go to $100,000.
 
I chastised him.  Why oh why would he put a stock he hoped to go up in his RRSP.
 
He was mystified.  How could I say such a thing?  EVERYONE put stock they expected to go up in their RRSP didn't they?  
 
I said that the only stock that should go in an RRSP is a stock you expected to go down and could not sell for some reason or other.  Maybe, for instance, you are a company insider and you know the stock is going to go down but to avoid being labeled as a Martha Stewart wannabe, or so that the market does not know you are unloading your own stock, you stick the dog in your RRSP so that you get the biggest write-off.
 
Let's pretend that "George's" $1,000 of stock does go to $100,000 in his RRSP and he sells it and takes the money out.  Well, he will owe $43,000 in tax assuming he made $60,000 somewhere else.  
 
How much did he save by putting the $1,000 into the RRSP?  About $430.00 How Much has he got left after taxes?  About $57,000.00
 
Let's pretend that he had $570 in his blue jeans and borrowed $430.00 from the Bank of Montreal or TD or Royal or, or, or.  He would have $1,000 worth of the same stock and when he sold it for $100,000 two years later, he would have to pay back the $430 to the Bank and about another $30.00 in after tax interest. And he would 0we 43% taxes on ½ of the capital gain of $99,000. I think that is about $22,000 or so.  
He would have about $77,000 left if he did NOT put it into the RRSP and about $57,000 left if he put it into an RRSP.  
 
It gets worse if it had been a dividend bearing stock.  If a dividend bearing stock is in the RRSP, the RRSP loses the dividend tax credit this year and next year and the year after that and the etc, etc, etc.  Then when you cash it in you pay double the tax on any capital gain and have to pay full tax on the dividends which would have been largely after tax dollars outside the RRSP.  Ask your investment advisor to explain this to you.
 
Now, everyone, (including those in my own office) who sells mutual funds for RRSP's will be horrified at this writing.  That is why I wanted this out AFTER the RRSP season.  
 
WHERE CAN MY RRSP MONEY  GO
 
Remember, the only thing that makes an RRSP deductible is a Registration Number issued by the CCRA.
 
Let me explain.... You have five $1,000 bills in your pocket, wallet or purse. You decide to use the services of the fictional United Dominion Bank. When you get to the branch you have picked out, you find yourself with a myriad of choices. I am assuming here, that you have already purchased a house or condo and have the mortgage paid off.
 
I am assuming you have no non-deductible car loans, Visa, MasterCard, or department store balances and have your retirement condo picked out and paid for so that if you get a divorce, you or your spouse will have a place to go. If you do not have all the above in place, think thirteen times before you buy an RRSP. But if you do, carry on.
 
Bank CHEQUING Account  
 
You could go to a teller and say I would like to deposit this in my checquing account. Unless it was an interest bearing checquing account, it would not earn any interest and even if it had interest, it would be one of the lowest rates that the bank pays when it rents money from you. There certainly would not be a tax deduction associated with it.
 
Bank Savings Deposit Account
 
You could go to the counter and say that you wanted to open up a savings deposit account. The accountant/teller could pull out the form, open the account, tell you what rate of interest you were going to get and you could give them the $5,000 and leave. Usually, you could not write a cheque on this account, but it would pay you significantly more interest than the first account. At this stage there would be no tax deduction and the interest received would be taxable when paid to you even if it was just credited to your account.
 
An RRSP
 
As you left the bank, you might see a sign that says RRSP, turn around and ask, "What is an RRSP?" The same person with whom you just left your money could explain it to you. You could say, "I need a tax deduction, I want one of those instead." All the bank person would have to do is tick off a box on the forms you have already filled out and you would have an RRSP. No bells would RRRRING, no gongs would GONG, no one would come rushing out to make sure that you knew what you were doing. And, more importantly, the bank would put your money into the same drawer or vault that it was going into before you said "I want an RRSP."
 
So, an ordinary bank savings account can be an RRSP. It will be safe, as it is almost always (do check) guaranteed by CDIC. It will not pay a lot of interest, but it is easy and safe and you understand it better than most other options.
 
When you get to the office and tell your co-workers what you have done, someone (there is always someone) says, "Why didn't you put it into a GIC? You would get a higher rate of interest and it will sure add up over the years."
 
GICs and Term Deposits
 
You dutifully return to the bank, talk to the same person and transfer your $5,000 to a Term Deposit or a GIC.  There is no problem because of the amount. If you had had less than $500, the institution would likely suggest that you wait until you had $500. A Term Deposit is strictly speaking the wrong vehicle here because it will usually only run 30 to 364 days. It will usually pay a higher rate of return, but you have to roll it over continually and you will likely opt for the GIC with a one- to five-year term, and a "locked in" interest rate that will usually exceed any savings account.
 
However, you could ask for a variable rate GIC where the interest rate can go up or down. Because the institution is not locked in, it will pay a higher 1/4 to 1% more interest to start. Most Canadians opt for GIC type RRSPs.
 
Again, they are safe and secure, and if you are worried about the Canadian dollar, many institutions will even let you have your account in US dollars. Beware though. With the US dollar account, DCIC does not usually apply. One of the problems I regularly run into, is that people will have all their eggs in one set of interest rates, i.e., all their certificates come due at the same time. This is a lot easier, but leaves you at the whim of the economy. If you are "into" GICs, vary their redemption dates. It is more work, but it will mean that you do not have them all coming due at a time 
when interest rates are low. Of course, you also lose some highs. But you should do better on average.
 
INDEXED FUND RRSP  
 
This is indexed to the Toronto Stock Exchange (and/or the New York Stock Exchange and/or the price of gold in New York). You can mix and match and you receive a variable interest rate depending upon those indices. It has CDIC guarantees and has a little gambling in it at the same time.
 
Mutual Funds
 
You spend a peaceful evening, proud as punch about your investment, but on the subway or SkyTrain  the next morning, you hear two well-dressed business types 
discussing their RRSPs. They are talking about 11% and 15% returns. This is interesting. All you are getting is 11%. Obviously if  6 % is better than 3% (the reason you went from the savings account to the GIC), then 11 or 15% is a lot better than  6%. You listen intently. Ah ha, they have their RRSPs in Mutual Funds ( or was it that they have Mutual Funds in their RRSPs?). No, they bought Mutual Funds and they were registered. That's it, the Mutual Funds are the RRSP. (In fact, all three are possible.) BUT NEVER, I REPEAT NEVER PUT A MUTUAL FUND IN AN RRSP OR REGISTER A MUTUAL FUND FOR RRSP PURPOSES.
 
Please note, I am NOT saying DO NOT BUY A MUTUAL FUND. I am saying "do not REGISTER a mutual fund for RRSP purposes." When you do, you lose the favourable tax treatment of capital gains tax rates and exemptions, and you lose the annual dividend tax credit. When you buy a mutual fund, you buy management, pure and simple. You see  buying a mutual fund is simply buying a share of a company or organization which buys shares, or bonds, or real estate, or Treasury Bills or socially responsible businesses and gold. The mutual fund management takes large amounts of money and buys a wide range of investments depending upon their stated objectives i.e., they may be a growth fund picking speculative securities or an income fund looking for high dividend paying stock with some high yield bonds or a bond fund specializing in high yield interest bearing instruments only. Others invest in commercial real estate across the country. However, since the best performing mutual funds have been generally invested out of the country and a mutual fund with more than 30% foreign assets cannot be in an RRSP, by registering, you lose the chance for better gains. At any rate, you decide that you would like to get one of these Fixed Income Funds. And, miracle of miracles, you find out that you do not even need to leave your bank. The same person can switch you over, and even though there is usually a service charge (or they will not let you) for cancelling your 
GIC, because this is all happening in two days, and you tell the nice person at the bank that they did not explain all your options to you, they transfer your money into a Fixed Income Fund paying on average a couple of percentage points over your GICs. 
 
Then, you visit you brother for dinner on the weekend, and he tells you all about this completely safe growth fund he has which survived the October, 1987 stock market crash and has still paid out 18% over the last 20 years.
 
My gosh, that sounds safe, and 18% is so much better than 11% that the next day you are back at the bank. You are lucky, they still haven't sent in the paper work (if they had, you would have likely paid a 3 to 8% service fee because of a Front End Load), and they roll your $5,000 into the Equity Growth fund you have been dreaming about. With 18%, your retirement will be assured.
 
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