Retirement investing: 3 surefire ways to make the most of your RRSPs

Registered Retirement Savings Plans (RRSPs) are a great way for investors to cut their tax bills and make more money from their retirement investing.

RRSPs are a form of tax-deferred savings plan. RRSP contributions are tax deductible, and the investments grow tax-free. (Note that you can contribute up to 18% of your earned income from the previous year, to a maximum of $21,000, rising to $22,000 in 2010). March 1, 2010, is the last day you can contribute to an RRSP and deduct your contribution from your 2009 income.

When you later begin withdrawing the funds from your RRSP, they are taxed as ordinary income.

Here are 3 retirement investing strategies you can use to make the most of your RRSPs, both now and in the future:

1. Hold mutual funds in your RRSP: At year end, mutual funds distribute any capital gains they have made during the year, after deducting any capital losses, to their unitholders. So, you may have to pay capital gains taxes on your mutual-fund holdings, even though you haven’t sold.

If you hold mutual funds outside of your RRSP, you’ll have to pay capital gains tax on half of those realized capital gains. So, as part of your retirement investing plan, we recommend that you hold mutual funds in an RRSP.

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2. Keep higher risk investments outside of your RRSP: We continue to believe that holding higher-risk stocks in your RRSP is a poor retirement investing strategy. That’s because if you hold them in an RRSP and they drop, you not only lose money, but you also lose the tax-deduction value of a loss in your RRSP. Outside your RRSP, you can use capital losses to offset taxable capital gains in the current year, the three previous years, or any future year.

You also lose the opportunity for tax-free compounding that the money would have enjoyed within your RRSP. This is a crucial part of successful retirement investing. That’s because, after about 7 years in an RRSP, the ability of an RRSP contribution to grow and compound free of tax is usually worth more than the initial contribution itself. That’s why RRSPs are a bad place for aggressive investments of any kind. The potential losses that these investments could suffer are just too costly.

3. Consider RRSP withdrawals only in years of little or no income: Making early withdrawals from your RRSP only makes sense when you’re in a low income-tax bracket, and you have exhausted all other means of income. That includes periods when you are ill, say, or unemployed.

If you still have funds left over after you’ve made a withdrawal, a good place to put them is in a tax-free savings account (TFSA). Like an RRSP, TFSAs shelter future gains from tax. But unlike RRSPs, withdrawals from your TFSA are not taxable.

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