Many of us in Canada have registered retirement savings plans (“RRSP”), registered retirement income funds (“RRIF”) and/or tax free savings accounts (“TFSA”). These are all terrific vehicles for accumulating wealth. These are all called “registered” plans meaning that they are recognized by our revenue authorities as tax-incentivised wealth management accounts. All of these plans are registered with the Canada Revenue Authority and are provided by approved service providers. Banks, trust companies, insurance companies and certain cooperatives are well known approved service providers. Contributions can be made on your own behalf or on behalf of your spouse up to and including the year you and your spouse turn 71.
When an individual opens up a registered plan, it is not the individual’s account per se, but an account that has been established by the service provider for the benefit of the individual. It is a “trust”. The account is registered with CRA and it has attached to it the benefits conferred on it by the legislation governing the benefits the government employs to fuel the incentive.
Five simple steps to use your Big Bank RRSP to buy non-bank product:
- Confirm the non-bank product is RRSP eligible with the help of a licensed advisor like Fundscraper.
- Identify how much you want to invest in the non-bank product.
- Instruct your bank to reduce to cash that amount WITHIN your RRSP account – your account will thereafter have a component of bank product and cash!
- Open up a self-directed RRSP account.
- Transfer the cash component to the self-directed RRSP.
- Issue a payment instruction telling the self-directed RRSP what to buy.
RRSPs – How they work
RRSPs are the most popular and well known registered plans in Canada. RRSPs are established by individuals or often by individuals together with their employers. Our governments want people to save for their retirement. What our government allows us to do is to contribute a certain fraction of our salary each year and on that fraction the government will not tax us today! Therefore, if you are making $100,000, the government will allow you to contribute 18% of your earned income (or a maximum of $27,230 for the 2019 tax year). If you are to make the maximum contribution, the government would only tax you on $72,770! For folks taxed at source, that’s the reason you get your rebate after you make your contribution. Crazy, eh!
Once money is deposited into an RRSP the tax payable on that money (and any money that is earned by investing that money!) is deferred until it is withdrawn.
Eventually, you will pay tax on the $27,230. You pay tax on it when you withdraw – either in a moment of need or at the time you retire. If you withdraw it before your retirement, then you will pay all the tax at once on the amount withdrawn. If you wait until you retire, you pay tax on it (and whatever has accumulated on it) gradually over a period of time until the funds are exhausted.
RRSPs are excellent investment vehicles and should be maximized immediately after paying off your credit cards! In generally all cases, discharging credit card debt (which is different from other kinds of debt like mortgages) takes priority over RRSP contributions.
Setting up an account
Opening up an RRSP account is very simple – simply mutter the letters “R-S-P” under your breath in front of a bank teller and you’ll be set up within minutes. If you have no idea what you’re doing, don’t worry, you’re in good company with the majority of Canadians. Happily our banks are very good helping opening these accounts and capitalizing them with your savings. You will hand your bank a cheque for “x” amount of dollars which will be deposited in the account. Next your bank will invite you to tell it how to invest that deposit. A myriad of investment options will be put in front you – you will not understand any of them – and you’ll be encouraged to pick three among which you will sprinkle your investment. They are all public market funds of one kind or another sponsored by the bank – of course. Obviously, you can’t go wrong! You’ll walk out of the bank slightly bewildered but feeling pleased with yourself. You have done something your parents will have approved!
Time passes and we diligently revisit our RRSP account each year to go through the same ritual. On average, we are never quite certain what the person behind the desk is investing our money into, but the individual’s enthusiasm for how they are going about the task reassures ourself that at least one person seems to know what they are doing. Our account generally moves at a glacial pace in the direction of the capital markets – we move ahead a few inches, then back, then forward again. Generally, we are happy to see it’s still there year after year.
While sitting at the boardroom table, you overhear one of your employees discuss how she has just purchased units in a private mutual fund trust that fully invests in commercial mortgages with her RRSP. She’s anticipating a return of 8% per year. Your first thought is that you pay her too much. Your second thought is “Wow, that’s really smart” and your third thought is “How do I do that?”
You have worked hard and you have accumulated a tidy sum in your RRSP. It’s hardly the lotto but it’s a good chunk of cash. The returns have been mediocre, but you’ve been reassured year after year that it is at least “safe”. You’re now wondering if “safe” is going to pay the bills when and if you retire. You have heard of dozens of different investment opportunities that you’ve let go of because you never thought you had the means to make the investment – you’re putting all your excess cash in your RRSPs. If only you could have used that money instead for those missed opportunities!
Have Your Cake and Eat It Too!
The first step is to move out of your comfort zone. You can actually take control of your own money and invest your RRSP into products that are not offered by your bank. This is a novel concept for a majority of Canadians.
What Can Go Into an RRSP?
The first important question is whether the investment product can be held in your RRSP. In the language of CRA, the investment must be a “qualified investment”. A summary of what CRA considers qualified investments can be found in its publication Income Tax Folio S3-F10-C1, Qualified Investments – RRRSPs, RESPs, RRIFs, RDSPs and TFSAs. It is best to have a licensed advisor guide you in this exercise. The most common types of qualified investments are the following:
- money, GICs and other deposits
- most securities listed on a designated stock exchange, such as shares of corporations, warrants and options, and units of exchange-traded funds and real estate investment trusts
- mutual funds and segregated funds
- Canada Savings Bonds and provincial savings bonds
- debt obligations of a corporation listed on a designated stock exchange
- debt obligations that have an investment grade rating
- insured mortgages or hypothecs
- private arms length mortgages
- units of a mutual fund trust (like Fundscraper Property Trust!)
- shares of mortgage investment corporations (“MIC”)
What’s the Exempt Market?
If the product does not trade in the public markets, then it trades in the “exempt” market, or what some call the private market. There are strict limitations about who can invest how much in the exempt markets. Individual investors are generally broken down into three categories: “Accredited Investors” can invest an unlimited amount in the exempt markets; “Eligible Investors” can invest up to $30,000 in one calendar year (with some exceptions) provided an offering memorandum drafted in compliance with strict regulation is delivered them; and “Ineligible Investors” can invest up to $10,000 in any one calendar year provided they too receive an offering memorandum. There are specialized securities dealers who work exclusively in the exempt markets to facilitate the sale of securities in this market. They are called “Exempt Market Dealers” or EMDs. It is the job of the EMD to first assess how you may participate in the exempt market. Next the EMD will want to work with you to determine whether the investment is suitable for you. Simply because you can buy an investment product, does not mean you should! An EMD will help you decide.
You pull the trigger!
After conferring with your financial advisor / EMD, you elect to go forward and invest a fraction of your RRSP funds in an exempt market product that your advisor has confirmed is a “qualified investment” for RRSP purposes. You are now the master of your RRSP!
Your current RRSP account has $100,000 of bank sponsored mutual funds. You have decided with your investment advisor to invest $10,000 in a private real estate investment trust (a “REIT”) that is a qualified investment for RRSP purposes. The REIT has an agreement with a trust company to provide registered account services like RRSPs, RIFs and TFSAs. This is very handy!
In order to make the investment in the REIT with your RRSP money you first have to sell some of your bank sponsored mutual funds so that your bank RRSP holds 90,000 of mutual funds and $10,000 of cash. It is very important that the cash remains in your RRSP account! Explain to the bank what it is you want to do. You will not hurt their feelings. It will take a couple of days to do this.
Self-Direct RRSP Account opening and SubscriptionNext, you or your advisor or the REIT will advise the trust company you wish to purchase your interest in the REIT with RRSP funds. The trust company will invite you to open a “self-directed” RRSP account with it. This is very simple.
You will then enter into a subscription agreement with the REIT to buy $10,000 worth of units on behalf of your RRSP. The EMD and the REIT will generally help you complete this agreement.
The TransferThe trust company will next provide you a “Transfer Form”. You will complete this form according to its instruction and return it to the trust company. On this form you will indicate that you wish to move $10,000 from your bank RRSP to your trust company self-directed RRSP. The trust company submits this form to the bank and this begins the process of moving your money from one RRSP account to another RRSP account. Note – your money never leaves the RRSP environment! It takes about three weeks for this to happen. (It is a mystery to us all that our chartered banks can debit our account for a cup of coffee we buy half way around the world the nano second our bank card touches the Interac terminal, yet it takes weeks to walk money across the street from one bank to another.)
The Payment InstructionOnce the money arrives at the trust company, the trust company will ask you what to do with it! You will be asked to provide the trust company with a “Payment Instruction”. What this does is that it tells the trust company to go out on behalf of your self-directed RRSP and buy units of the REIT you wish to purchase with the cash in your RRSP! The trust company advances the cash proceeds from your RRSP account to the REIT and the REIT issues units to your RRSP account. You now own an exempt market product in your RRSP!
Conclusion – Remember the Risks!Investment in exempt market product which often holds the promise of attractive returns, may hold risks of which you must always be aware. The most obvious risk is that it doesn’t trade like publicly listed security. If you need to sell your investments to meet an unexpected circumstance, it may be very difficult if not impossible to sell or redeem your exempt market investments on a timely basis. Further, the information you may receive from the issuer of the exempt market product may not be as detailed as what you typically get from public company issuers.
It is imperative that you receive the advice of a registered exempt market dealer like Fundscraper when investing in the private capital markets!
Fundscraper Capital Inc. (FSRA 12859 / NRD 53460) provides a best-in-practice online environment for real estate investment. We deliver to investors – from private individuals to major institutions – multiple ways to invest in the property-backed opportunities that are available to our qualified members. With just a few inputs on any computer or tablet we invite investors to do in minutes what used to take hours. At Fundscraper, we’ve taken out the obstacles to private real estate investment. We’re not simply a brokerage; we’re a community of like-minded investors wanting well-diligenced transparent transactions that promise both security and return. Fundscraper is an exempt market dealer registered with the Ontario Securities Commission (as well as the British Columbia, Alberta, Quebec and P.E.I. Securities Commissions). Visit us at www.fundscraper.com and sign up to learn more at: https://my.fundscraper.com/signup!