A registered retirement savings plan (RRSP) gives you a fair degree of latitude in how you financially prepare for your retirement. In this regard, the government permits Canadians to buy, sell, and hold a number of investments in their RRSPs. However, not all investments qualify, and it’s important that a non-qualified investment not be purchased. Otherwise, there can be substantial tax penalties.
There are two basic varieties of RRSPs. The first is managed by an external party. In contrast, the second kind of RRSP is self-directed, in which the holder of the RRSP makes decisions about what specific investments to include in their account.
RRSP investment rules
The Canada Revenue Agency (CRA) sets in some detail the types of investments that are allowed to be held in an RRSP. These are known as “qualified investments.” Here are some of the more common qualified RRSP investments:
- Individual stocks, so long as they trade on a major domestic or foreign stock exchange
- Government Bonds
- Corporate Bonds
- Savings Bonds
- Mutual Funds
- Index Funds
- Exchange-Traded Funds (ETFs)
- Mortgages and mortgage-backed securities
- Shares in Canadian small businesses
- Gold and silver
Here is a primer on some of the common RRSP investments:
Many people hold stocks (also called equities) in their RRSPs. Stocks offer two main potential benefits. First, there is the potential for capital gains, where the price of a stock you purchase may increase. Second, many companies pay dividends to their shareholders.
Bonds (fixed income)
Bonds are part of an investment category often referred to as fixed income. Essentially, a bond is a loan to a corporation or a government. In exchange for the use of your money for a specified period of time, the borrower promises to pay you interest plus your money back when the bond matures. For the purposes of RRSPs, Canadians may buy and hold corporate bonds, government bonds, as well as government savings bonds (which will be eliminated in 2017).
Many Canadians hold mutual funds in their RRSPs. A mutual fund is an investment pool managed by professional money managers who oversee the assets of many different individuals and businesses. Mutual funds usually own a basket of stocks and/or bonds tied to either a particular market or a specific sector within a market. These funds charge unit holders an annual management fee, known as a management expense ratio (MER), which is expressed as a percentage of the money under management. For example, a fund with an MER of 2% will charge investors that percentage of their money every year based on the market value of the fund.
Guaranteed investment certificates are fixed-income investments offered by financial institutions in Canada. In exchange for the use of your money for a specified period of time, a bank, insurance company or other company will pay you interest. At the end of the GIC’s term, you’ll also get your principal back. The vast majority of GICs are insured by the Canada Deposit Insurance Corporation (CDIC) or provincial credit union equivalent.
Exchange-traded funds (ETFs)
ETFs are baskets of stocks or bonds that investors can purchase on an exchange. For instance, an ETF tracking the energy index of the Toronto Stock Exchange (TSX) will hold shares in many different Canadian energy companies. Unlike mutual funds, ETFs are typically “passively” managed. What this means is that there isn’t a professional manager deciding what stocks to buy. Rather, the ETF provider simply buys shares and only makes adjustments by buying and selling as needed to keep the fund in line with the benchmark.
Canadians can have their RRSP investments managed by an investment advisor in some form or another. However, individuals are also allowed to manage all their RRSP investments on their own. This can be done by opening up an online brokerage account and constructing a portfolio by buying and selling stocks, bonds and other securities. Only people with the time and expertise to do so should go down this route, however.
Certain investment are not permitted to be held in an RRSP. These include:
- Businesses in which you have an interest of 10% or more
- Precious metals other than gold and silver
- Commodity futures contracts
- Shares in private holding companies and private foreign corporations
- Debt you own
- Personal property such as antiques or furniture
How to choose the best investments
Before you begin investing money in your RRSP, you’ll first want to determine your investment goals and your risk tolerance. This will depend, in part, on your age and your level of investment knowledge. As a general rule, younger Canadians can afford to take more risks with money in their RRSP because they can ride out market volatility in the near term. However, as you get closer to retirement you’ll want to be more conservative with the money in your RRSP so you can be more confident it’ll be there when you need it.