Around this time of year, there’s a lot of talk about RRSPs. We see it on television, we read it in the newspapers, our bank tellers mention it and our financial advisors push it. One thing that I encounter is that a lot of people do not quite get the real concept of RRSPs. An RRSP is a government-backed program that encourage Canadians to save for their retirement by deferring their tax. A key word here is deferred not free. Simply put, the government will not tax you for a portion of your income that you will put away for your retirement. But if you take out that portion, you will be taxed on it as income. The whole concept hinges on the fact that when you retire, in other words, when you stop working, you earn less, therefore, when you finally take out your savings, your income is less and in this way, your tax is less. It’s a great tax saving initiative especially for those who will not have a pension or who will have very little pension when they retire. Furthermore with the uncertainties of the pension fund these days, it is smart to put some money for retirement. But the problem occurs when people take out their RRSPs pre-maturely. The withdrawal of the RRSPs will make your tax burden bigger for that year. It will add back what was previously taken off as income when you first took your RRSP.

The RRSP is also a great vehicle for saving for a downpayment for a home or in case you go back to school. These programs are called First Time Home Buyers Plan or LifeLong Learning Plan. But keep in mind that the main purpose of an RRSP is to save for your retirement, so the government are willing to let you borrow from your Retirement Savings Plan without tax, and the key word here is borrow, but you have to put it back in your Retirement Savings Plan in 15 years. CCRA will give you a schedule of payment. You have a minimum that you have to return in your RRSP or if you do not put it back into your RRSP, they will take that minimum as income and tax you on it.

The following are alternatives to the RRSP:

. Non-Registered Funds: With non-registered funds, you will be taxed on the interest income but there are funds out there called corporate class where you will not get taxed until you withdraw your money from the account and they will tax it as dividends which are lower than interest income.

. Life Insurance: There are some plans out there, one being Universal Life that allows the policy holder to save money up to a maximum without incurring tax. The good thing about this policy is that it allows you to invest in different funds or guaranteed options. The bad thing is most policies do not allow you to take out money within a set number of years. These funds are not cash values, they are either called reserves as in the case of Universal Life plans or they are called withdrawable premium funds. Read your policy or ask these questions to your financial advisor.

. Savings account: This way is probably the simplest. Just open an account in your bank and keep it there until you need your money. The problem is you are losing out in the earning power of your money. But, it’s there and it’s ready for your use, anytime. And you’ve already paid tax on it. Bear in mind though, that if you do earn interest in the savings account, no matter how small, you are taxed on that interest.

Someone once said, probably a Canadian, that there are only 2 things in life that are certain: death and taxes. You cannot escape them both, but you can certainly be smarter about your taxes.