Accumulating enough money to live on once your working years are over is no easy task. However, you can use certain strategies to help increase the effectiveness of your RRSP as a retirement-saving tool. For starters, it is important to invest early and choose the right asset allocation strategy for your portfolio. As with all retirement planning, the decisions you make now will largely determine the amount of money that will be available to you when you retire.
1. Start Contributing Early
Even if you can only invest $100 each month, enroll in a monthly investment plan so that you can automatically contribute to your RRSP. Many financial institutions also provide special "catch up" loans that allow you to borrow money to accelerate the growth of your RRSP. Of course, this loan has to be repaid with interest. If you'd like to find out more about RRSP catch up loans, contact your bank and it will give you all the details you need.
Below, we've charted the value of a $1,000 investment growing at a tax-free rate of 8% per year against another investment of $1,000 placed just 10 years later, growing at the same tax-free rate. Although the first investment was made only 10 years before the second investment, that first investment is worth twice as much as the later investment 47 years later. The effects of compounding are staggering. This clearly demonstrates how advantageous it is to start investing when you're young.
2. Don't Wait Until RRSP Season To Invest in Your RRSPs
Many people wait until tax season to contribute to their RRSPs. If you do this, however, you'll be slowing the rate of growth of your portfolio. If you invest smaller amounts gradually throughout the year, the small amounts grow through the year. This may not sound like a big advantage, but over decades the amounts can really add up. (For more on this investment strategy, see Dollar Cost Averaging Pays.)
3. Don't Waste Money
Many investors will let cash sit in their RRSP accounts while trying to decide what to buy. This is not a good idea. Instead, you should always have your money transferred into a money market mutual fund that has no minimum hold period and no loads. The reason for this is that these funds pay out a rate of interest that is usually more than 1% higher than your normal savings rate. There are even some RRSP accounts that pay no interest whatsoever.
4. Limit Taxes
Keep an eye on your RRSP portfolio as well as your regular investment portfolio. Canadians are permitted to swap investments between investment portfolios and RRSP accounts. So, if you have a stock in your RRSP account that has done particularly well (and you don't think it will appreciate much more) and a stock in your regular investment portfolio that has done poorly, swap them with each other. This strategy will allow you to avoid having to pay any capital gains tax on a stock's increase in value. The security that has done poorly has collected capital losses, which can help to offset capital gains. After swapping these securities, you can wait for the stock that has done poorly to rise in value without any tax consequences. Remember, the RRSP accounts are more beneficial to you when the investments inside are rising in value. If you have investments that are declining in value, you may be able to claim capital loss deductions on your income taxes.
5. Don't Take Money Out
Leave the money in your RRSP alone - early withdrawal should only occur as a last resort. Remember, in an RRSP account, you are not taxed on gains. As a result, a 5% return on your registered account is equivalent to a return of approximately 6.5% outside of your registered account. If you factor in income from dividends and interest, the spread increases even further because of the higher tax rates these types of income incur.
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