The RRSP deadline is an important date to keep in mind for successful investing

RRSPs are a form of tax-deferred savings plan. They are a little like other investment accounts, except for their tax treatment. RRSP contributions are tax deductible, and the investments in them grow tax-free.

Investors have 60 days after the end of the year to meet the RRSP deadline. For instance, in 2017, March 1 is the last day to contribute to an RRSP and deduct your contribution from your 2016 income.

How to open an account before the RRSP deadline: What to know first

Registered retirement savings plans, or RRSPs, are the best-known and most widely used tax shelters in Canada.

You can put money in RRSP tax shelters each year (up to a limit based on your income) and deduct it from your taxable income. You only pay income tax on your investment, and the income it earns, when you make withdrawals from your RRSP.

In a way, investment gains in RRSP tax shelters give you a double profit. Instead of paying up to 50% of your investment gains in taxes, you keep 100% of them working for you until you take money out.

Three ways to invest in RRSPs

There are three common ways to invest in an RRSP. The first is making automatic, monthly payments. This is widely accepted as a good way to build your RRSP and to develop investment discipline. You do this through a financial institution which will generally direct the money into mutual funds.

Second, if you have more time to review your investments, you can open a self-directed RRSP, which allows you to hold different types of investments. You can certainly manage the account yourself, but you are not obliged to do so: some people have a financial advisor handle their self-directed RRSPs.

The third way to invest in an RRSP is the one that generally considered the least effective. Investors are often warned not to wait until the contribution deadline looms in February to rush money into an RRSP. If you contribute earlier and on a regular basis, you have more tax-free returns accumulating over the year.

Still, if you have money to invest, there is nothing wrong with tucking it into your account before the RRSP deadline if you have unused contribution room.

What to hold in your RRSP

Generally speaking, it’s best to hold interest-bearing investments inside an RRSP. That’s because, of the three forms of income (interest, dividends and capital gains), interest is the highest taxed. Dividend-paying investments, and those expected to yield capital gains, are best held outside. (Unless you just hold stocks, and then they are okay to hold in an RRSP.) Some investors only invest RRSP funds in interest-paying securities, because they hate to see tax advantages go to waste. However, this makes less sense when interest rates are low, as they are today.

Stocks come with two key tax advantages. The dividend tax credit applies to dividends from Canadian companies, so they are worth around one-third more, after tax, than the same amount of pre-tax income from interest or employment. This advantage goes to waste in an RRSP.

For example, an investor in the 50% tax bracket would pay 50% tax on interest income. Dividend income, after factoring in the dividend tax credit, would be taxed at only around 29%. Capital gains would be taxed at just 25%.

So, if you hold dividend-paying stocks in your RRSP tax shelters, you defer taxes, but lose the dividend tax credit. When you withdraw money from your RRSP, you’ll pay taxes at the same rate as regular income, regardless of how you earned the money. So it’s best to hold dividend-paying stocks outside your RRSP.

Possible returns from opening an account before the RRSP deadline

You need to determine what kind of returns you are looking at from your RRSP. Many investors are confident they are taking concrete steps toward a secure retirement. But are those steps based on realistic calculations?

Let’s say you’re 50 and you want to retire at 65. You have $200,000 in your RRSP, and you expect to add $15,000 in each of the next 15 years. To determine if this is enough to retire on, you need to make assumptions about investment returns and income needs.

Long-term studies show that the stock market as a whole generally produces total pre-tax annual returns of 8% to 10%, or around 6% after inflation. For retirement planning, we’ll assume a 6% yearly return, and disregard inflation. Your $200,000 grows to $479,312*, and your yearly $15,000 RRSP contributions add up to $370,088, for total retirement savings of $849,400.

*****Be sure to check your math. There are many compound-return calculators available online. For example, you can find a comprehensive compound-return calculator at the Bank of Canada’s web site.

If you continue to earn 6% a year, and you withdraw $50,964 a year (6% of the $849,400 in your RRSP), you can avoid dipping into capital until your 70s, when RRIF rules call for steadily rising withdrawals.

However, if you start taking money out faster, or earn lower returns, you’ll run out of money. If you withdraw $90,000 a year while earning 6%, the money you’ve accumulated will last just over 13 years. If you earn 5% but withdraw $90,000 a year, your money will be gone in just over 12 years.

Do you feel more confident now that you know the RRSP deadline, how to open an account and what to hold in it? Share your thoughts with us in the comments.