Beware of RSPs
Ron Tarter is a licensed investment advisor at Planmar Financial Corp. in London and a third-year Western student. He would love to address your questions! Send queries and comments to firstname.lastname@example.org.
Most students should not buy Registered Retirement Saving Plans (RSPs). Saving money is not a poor choice, but I do question whether registering investments as an RSP is beneficial to students.
Instead of contributing to an RSP as a student, why not save allowable contributions until you enter the work force, a period of higher, taxable income. In the meantime, invest in unregistered RSP-eligible securities.
RSPs are a gift from the government, encouraging individuals to save for their retirement. The mechanics of the plan allow you to deduct up to 18 per cent (to a maximum of $13,500) of your income each year and invest that amount in a tax-free RSP. In other words, if you earn $50,000 in a year and contribute $5,000 to an RSP, the government only charges income tax on the remaining $45,000. The other $5,000 is retained tax-free.
Gains or interest realized on investments that are not registered as RSPs are considered investment income, added to your regular income and taxed at your marginal tax bracket. Investments registered as an RSP are not taxable, or "sheltered." Because the investments are not perpetually taxed, they will grow exponentially faster.
In the case of lowering taxable income, most students fall into the same category. Inherently, we have low incomes and pay little or no income tax. Students have a low marginal tax rate, so making an RSP contribution has negligent tax implications.
Until recently, you could only save unused RSP contributions up to seven years. New legislation allows you to accumulate unused contributions indefinitely. There is no rush to register investments as RSPs in fear of losing allowable contributions. It is in most students best interest to invest their savings in RSP-eligible securities, such as certain mutual funds, guaranteed investment certificates (GICs) and government bonds. This will save allowable RSP contributions for years when your income and tax savings are potentially higher.
Another regulation states that contributions do not have to originate as cash. RSP contributions can be any RSP-eligible security. So five years down the road you can use the investment you bought today as an RSP contribution. The value of that investment will still be deducted from your taxable income in a later year when you will most likely be in a higher marginal tax rate. This translates into smarter financial planning.
If for some reason you need to cash in an RSP, let's say because you are a little short of funds one year, there are tax implications. The federal government will withhold at least 25 per cent of the value for tax purposes. Furthermore, when an RSP is cashed, that allowable contribution is indefinitely lost. You will not be able to replace that RSP in later years without lowering your allowable contribution limit.
As for the issue of tax-free growth within an RSP, there will be no substantial benefit to a student. Most students do not have large RSPs, so the taxable income incurred from investments are usually insignificant.
If income from investments is large enough to cause problematic tax implications, you probably do not qualify as "most students." If you are earning $20,000 or more per year, RSPs may be the viable route. Remember to always consult a licensed financial planner to assess whether or not an RSP will be beneficial to your unique financial position.