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RRSPs show clear advantages over open-account savings

You say you like ice cream? Then make a trip to Namco Nanja Town in Tokyo's Toshima-ku. According to the Mainichi Daily News website (June 29, 2004), you can buy the following new and exciting flavours at Ice Cream City there: spinach, garlic, tomato, seaweed, oyster, red wine, goat, chicken, lettuce and potato, wheat, shark fin, and something called "raw horse flesh." Each mouth-watering flavour is shown photographed on the package. Hey, it's enough to make any ice cream lover run for the hills.

It's interesting that a significant number of investors react to registered retirement savings plans the same way. Yet, the RRSP should form the cornerstone of any retirement savings plan if you're the average Canadian. Today, let's compare RRSPs to open accounts (non-registered savings) on six fronts.

Instant tax deferral. Don't overlook the tax deduction when contributing to an RRSP. It results in a tax deferral on the amount contributed. The deduction will defer taxes of up to 46 cents (varies by province and income level) for every dollar contributed. And there's a dollar value you can place on that tax deferral since the money is working for you inside the plan instead of sitting in Canada Revenue's coffers. Advantage: RRSP.

Tax-deferred earnings. An RRSP offers a tax shelter for earnings inside the plan. You won't face tax until you withdraw those earnings. I'll count this as an advantage, but this may not be as big an advantage as you might think. Why? Because you can still invest very tax-efficiently outside an RRSP if you're careful (avoiding highly taxed interest income is a start, which doesn't mean taking on more risk given the gamut of structured investments today). Advantage: RRSP.

Tax on withdrawals. When you liquidate your savings to provide for yourself in retirement, you'll face tax on every dollar withdrawn from your RRSP. If you make a withdrawal from your open account, you'll only face tax on the growth in value of the securities you sell. It's an advantage to open accounts, but the advantage is greatest for higher-income earners with a high marginal tax rate. Advantage: Open accounts.

Investment limitations. Your RRSP has some investment restrictions. For example, there are contribution limits each year ($15,500 for 2004), but most people don't invest the maximum anyway. In addition, just 30 per cent of the cost of your plan assets can be foreign content. Yet, there are ways to side-step this restriction (with the use of RRSP clone funds, for example). There are also other less common investments that may not be allowed in your RRSP (real estate, for example), although the investment options for RRSPs are broad enough to satisfy the needs of most investors. Advantage: Open accounts.

Income splitting. In an ideal world, you and your spouse or common-law partner will have equal incomes in retirement. This will save you tax.

Although it's not impossible to split income using an open account, it's still difficult. A spousal RRSP allows you to contribute money to an RRSP for your spouse such that you receive the deduction, but your spouse can pay the tax on withdrawals. It's a simple way to accomplish income splitting. Advantage: RRSP.

Psychological benefits. Most people believe that they should leave their retirement savings untouched until they retire. When money is inside an RRSP, people tend to be less willing to make withdrawals from that plan than from their open accounts. In addition, an RRSP has a contribution deadline (March 1 this year), which adds to the urgency to contribute. Not so with open accounts. Advantage: RRSP.

tcestnick@aic.com



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