Registered Retirement Savings Plans (RRSPs) don’t get enough credit for their benefits since the Tax-Free Savings Accounts (TFSAs) came along.
So, I’d like to share three ways you can make the best use of your RRSP.
Reduce your income taxes for the year
If you’re in a high tax bracket, contributing to RRSPs can substantially reduce your income taxes. If you’re in a low tax bracket, you might refrain from contributing to RRSPs to allow your contribution room to build up for more tax savings in the future when you get to a high tax bracket.
Invest for retirement
If you have trouble saving money, you may want to contribute to RRSPs no matter which tax bracket you’re in, because it’s too easy to withdraw money from other accounts, such as TFSAs and non-registered accounts.
However, there are penalties for withdrawing from RRSPs, unless you’re taking out money through the Home Buyers’ Plan or the Lifelong Learning Plan.
RRSPs were created to encourage saving and investing for one’s retirement. What you earn inside RRSPs are compounded tax-free until you withdraw funds.
The withdrawal amount is taxed at your marginal income tax rate at the time of withdrawal. So, what’s earned inside is essentially tax-deferred.
You can invest for interest, dividends, capital gains, foreign exchange gains, etc. in your RRSPs. Since interest rates are low, it’s logical to explore stock investing for higher returns to secure a comfortable retirement.
For example, you may consider holding Bank of Nova Scotia (TSX: BNS)(NYSE: BNS) for its growth potential in Latin America. The bank offers a safe yield of almost 4% which can continue growing at a compound annual growth rate of 5-7% for the next few years.
Invest in U.S. dividend stocks
Bank of Nova Scotia pays eligible dividends which are favourably taxed in non-registered accounts. TFSAs are also great places to hold Canadian stocks that pay out eligible dividends.
Instead, leave room in your RRSP to invest in high-yield U.S. stocks to save more taxes. There’s a 15% withholding tax on U.S. dividends in other accounts, but not in RRSPs or RRIFs.
For example, Simon Property Group Inc. (NYSE: SPG) offers a decent 4% yield which can grow at a single-digit rate in the next few years. The shares are a reasonable value after a meaningful pullback.
Simon Property is the largest retail REIT in the U.S. and ranks at the top among global retail real estate companies. The REIT has a quality portfolio of premium outlets and malls and earns about 8% of its net operating income internationally.
Be aware that you don’t invest in U.S. master limited partnerships which can have big withholding taxes on their distributions north of 30%, even if invested in RRSPs.
Investor takeaway
RRSPs are best for investing for retirement, especially if you’re in a high tax bracket. RRSP contributions reduce your taxes for the year and allow you to grow your savings and investments in a tax-deferred environment. Canadians will find that the RRSP is a great place to earn U.S. dividends. Just avoid master limited partnerships.
