Registered Retirement Savings Plans – The Basics
In 1957, the Canadian government created a program structured in such a way as to give Canadians the incentive to save for their own retirement, and the Registered Retirement Savings Plan (RRSP) industry was born.
The RRSP program allows savings for retirement to grow tax free in a special savings plan registered by the Canada Revenue Agency.
The main advantage of an RRSP is that contributions to the RRSP are 100% tax deductible against any other source of income in the contribution year. In addition, every Canadian that files a tax return creates RRSP “room”, and currently the amount of room created is equal to 18% of earned income, to a certain maximum every year (i.e. based on rate of inflation). The good news is that even if an individual does not contribute their maximum in a given year, the amount left over can be carried forward for use in future years.
RRSPs Are Under Utilized
The RRSP industry is large in dollar terms. Canadians currently hold more than $590 billion in their RRSPs, but billions more of contribution room has not yet been utilized. Further, only four in ten Canadians, or 38 per cent of us contributed to an RRSP in 2011, according to BMO’s Annual Post-RRSP Deadline Study.
Let Compounding Change Your Net Worth
An RRSP has a significant benefit that is often under- appreciated; tax-free compounding growth! Tax-free compounding because you do not pay tax on gains or income until money is withdrawn, whether prior to retirement or after retirement. Therefore, your money can compound faster in an RRSP.
Will Your RRSP Deliver Retirement Lifestyle Choices?
Let’s get straight to the point. At an annual contribution rate of $4,670 (average contributions in 2011 according to BMO’s study) over a period of 30 years, you will have contributed $140,100 to your RRSP. Now let’s assume that over this 30- year time period you earn a 5% compounded rate of return and the annual inflation rate is a flat 2%, you would end up with a real return of $237,688. This may sound like a lot of money, but is it really?
Let’s consider a common expenditure goal of Canadians at retirement; a motorhome. The average price for a motorhome in 1982 was $24,500 and today’s average price is $128,000, that’s a whopping $103,500 or 400% jump in price over 30 years! What if today’s average motorhome price jumps from $128,000 to $520,000, a 400% increase over the next 30 years? With only $237,688 in your RRSP, or with $500,000 saved, what kind of motorhome and/or retirement lifestyle have you planned for yourself? The solution starts today, and all we need to consider are these two questions: 1) Are we willing to contribute more money annually to our RRSP?; and 2) Are we ensuring our RRSP is earning a maximum risk-adjusted return?
No Kidding – An RRSP is Not an Investment
Many Canadians still think an RRSP is an investment onto itself, but it is not! Once you make a contribution to your RRSP, it is essential to invest and manage the money wisely to maximize annual growth.
Common RRSP Investment Choices
Many Canadians are unaware there is a wide range of investments that can be purchased within an RRSP. The BMO study found that in 2011, the investment choice for Canadians, with 59% of us investing in them, were mutual funds. For the rest of us, 25% chose GICs, 22% chose equities, 12% chose bonds and 6% chose ETFs.
Overlooked – Private Company Investments
The vast majority of today’s successful public companies were first a private company. Picking the right private companies for investment requires as much attention as picking a good publicly traded company. It is worth the effort since many private companies offer compelling capital gain opportunities. For income-orientated investors, many pay attractive dividends or high yields on their debenture/bonds. Finding private company investments that are eligible for your RRSP is no easy task either.
Private Company Investing & Exempt Market Dealers
Do not expect your stockbroker to introduce you to eligible private company investment opportunities for your RRSP. In Canada, Exempt Market Dealers are well known for their access to private company investments. To find out more about Exempt Market Dealers, go to the Exempt Market Dealer Association of Canada at www.emdacanada.com.
Private Company RRSP Service Providers
Knightswood Financial Corp. provides private companies with a simple solution that enables private companies to issue RRSP eligible debenture/bond products to investors. Knightswood has facilitated over 20 offerings totaling more than $260 Million.
Western Pacific Trust Company offers Self-Administered Registered Plans (RRSP, LIRA) and Tax Free Savings Accounts (TFSAs) to investors. Eligible private company investments are accepted for both RRSP and TFSAs.
Additional Source of Capital
Across all industries, there are private Canadian companies looking for effective financing solutions. Some of those companies have turned to Knightswood for an effective debenture offering solutions to successfully raise capital. Knightswood assists its Clients’ debenture financing activities by making their debentures eligible for their Canadian investors’ registered plans (e.g. RSPs, pension plans, etc). This, of course, opens up a vast amount of capital that would otherwise not be available to our Clients’ debenture offerings.
By working with Knightswood, the Clients’ investors will have two options to choose from:
- Investor can purchase the debenture with their cash and subsequently contribute the debenture to their registered plan and, if applicable, receive a tax deduction.
- The investor can use cash in their registered plan to finance the purchase of the debenture investment. This cash can come in the form of a new contribution or a transfer from an existing registered plan.
How Does It Work?
- Knightswood incorporates a subsidiary company (“Subco”) and subscribes for a nominal amount of share capital ($100 in common shares)
- Directors of the Subco are nominated by PrivateCo (or the General Partner, in the case of a limited partnership structure) and approved by Knightswood. Subco arranges for debenture financing from PrivateCo’s outside investors. The debentures are considered to be qualified investments for registered retirement savings plans and other deferred plans under the Income Tax Act (Canada). Knightswood provides Client with a registered plan eligibility letter.
- Knightswood and Subco enter into an Administrative Services Agreement documenting the fees, services covenants, warranties and other contractual arrangements that have been agreed between the parties. Knightswood is not involved day-to-day operations of Subco and does not participate in its profits or losses. As a result, there is no requirement for Subco to be audited or consolidated into the financial statements of Knightswood.
- Subco loans the net proceeds raised through its debenture offering to PrivateCo.
- Knightswood, Subco and PrivateCo enter into a Put/Call option agreement exercisable at any time during the term of the agreement. Upon the occurrence of certain events, PrivateCo has the option to purchase (or “call”) the shares of Subco from Knightswood at pre-specified price. Alternatively, upon the occurrence of certain events by Subco, Knightswood has the right to sell (or “put”) the shares of Subco to PrivateCo at the pre-specified price.
Marty Gunderson is an expert who helps companies navigate through the Exempt Market. He has served in a variety of leadership positions in the industry, from sales to issuer to dealer. He is the founder of www.BetterReturns.ca, a site that highlights a few quality exempt market offerings. To contact Marty, please email marty (at) idealeader.ca