The goal for your Registered Retirement Savings Plan (RRSP) is for it to grow steadily during your working years so that it’s there to support you when you retire.
But to make that happen, you need to choose investments carefully to ensure that your nest egg continues to build and is well protected.
It can all seem confusing, but it doesn’t need to be. To help you out, we’re going to look at what investments you are allowed to hold in your RRSP, what to consider when choosing investments, which ones are best for your RRSP and why, and which investments are best to be left out entirely.
What Types of Investments Can I Hold in My RRSP?
Investments that can be held in an RRSP include stocks traded on major exchanges, dividend stocks, bonds, mutual funds, exchange-traded funds (ETFs), guaranteed investment certificates (GICs), cash, savings deposits, savings bonds and treasury bills. There are also a few others that are more uncommon.
Factors to Consider When Choosing Investments
As you choose RRSP investments, a key issue to look at is your time horizon before you need the money — which hopefully is a long one as an RRSP is meant for future retirement savings, not short-term savings.
If you are younger and a long way from retirement you can take a bit more risk with your RRSP as you have time to weather the ups and downs of the market. If you are closer to retirement, you will want more conservative investments to ensure the capital in your RRSP doesn’t take a hit by a potential market downturn.
You also need to know your personal investment risk profile to decide how comfortable you are with investment risk and which investments are right for you and your RRSP.
If you are really uncomfortable with the idea that the value of your investments will fluctuate over time, you may want to stick to more conservative investments whose value is expected to be less volatile such as blue-chip stocks (considered top tier stocks), ETFs, highly rated bonds, GICs, and high-interest savings.
Which Are the Best Types of Investments to Hold in My RRSP and Why?
Because an RRSP is a tax-sheltered investment vehicle means certain investments — particularly those that are taxed at a higher rate — work better within an RRSP than an account that is not tax-sheltered.
An RRSP is a deferred-tax account. The investments in the account are sheltered from tax while they are in the account and are taxed when the money is withdrawn in retirement. The idea is that you contribute to an RRSP in your working years when you are in a higher tax bracket and withdraw the cash when you retire and are at a lower tax bracket, therefore saving tax.
Most people start investing with an RRSP because the income isn’t taxed until it’s withdrawn, and you receive a tax deduction for the RRSP contribution (a great bonus)!
Investment income, such as interest income from bonds, high interest savings accounts and GICs, is taxed at a person’s marginal tax rate, which is the tax rate you pay on your overall income. Those investments are best held in a registered account such as an RRSP.
However, capital gains from stocks and dividends are taxed at a lower rate. They are great investments for an RRSP as well, but if held outside a registered account they benefit from the lower tax rate associated with (what is called) capital gains.
Capital gains are accrued when you sell an investment for more than you paid for it. Only half of that gain, called a capital gain, is taxed at an investor’s marginal tax rate.
Investors with dividend income benefit from the Federal Dividend Tax Credit that reduces the amount of tax you owe. There’s a bit of a complicated formula for figuring out the taxes on dividends, but the key is that the rate on eligible dividends will be lower than your marginal tax rate.
The best advice is to focus on maxing out your RRSP and tax-free savings account (TFSA) before opening an unregistered investment account, which is fully subject to tax in order to benefit from this tax treatment.
Investments to Avoid in Your RRSP
One investment you don’t want in your RRSP or TFSA is an overly risky investment, such as stocks of more precarious companies, mainly because you cannot claim any losses against any gains with investments within an RRSP or TFSA because their growth is sheltered from tax. So, if you buy a stock that goes bankrupt, you simply lose the cash as well as the RRSP contribution room.
The aim of your RRSP is for it to grow steadily as you advance towards retirement. You don’t want this cash to disappear into bad or risky investments and leave you without adequate funds for your golden years.