Your Creative Retirement Plan
One of the few tax benefits still made available to Canadian tax payers is the RRSP, or Registered Retirement Savings Plan. Hopefully you find yourself in a position every year to make a contribution. The benefits of doing so can really add up since any contributions to a registered account act to defer taxes being paid by offsetting your employment income.
After contributions are made, very few Canadians understand the options that are available to them when investing through an RRSP plan. The challenge is a bit ironic. The palette of options that are deemed acceptable investments under the tax-sheltered plan is limited, but within each category (say mutual funds), the number of investment options is eye-popping. On top of that, many investors don’t appreciate the fee structure associated with fund management. Coupled with a low interest rate environment, savers across Canada are currently challenged to find reasonable returns.
So what should you do?
We found ourselves in the same predicament and sought to generate greater returns. We were pleasantly surprised to learn about the RRSP Mortgage. This is a vehicle approved by the CRA for use within a retirement savings plan that requires a bit more effort, but can generate steady long term growth and solid investment returns.
While an RRSP is not legally allowed to own a piece of real estate directly, your plan is able to lend money on a property. The loan needs a simple registration on title in the same way that a bank would secure their investment after providing you with a residential mortgage. Have you ever stopped to consider why your bank can offer you such an exceptionally low interest rate on your home loan? Consider the security of this investment compared to derivatives, an inflated stock market (like we see today), or a business. The beauty of real estate is that it always represents a physical asset that the bank can take back and sell to another in the event of loan default.
With a little research and prudent planning, the average RRSP holder can effectively act like the bank and lend money to others for a return. Here are a few things to keep in mind.
1. You can’t lend the money to yourself
There are very specific rules about who you can lend to.The relationship between the mortgagee (you) and the mortgagor (the buyer of the home) needs to be defined as an arms length transaction. That means no parents, brothers, sisters, husband, wife, children, or pets (let us know if you figure out this last one). As a result, you will be lending to someone that you may not know and due diligence is key.
2. You need to set up a specific type of RRSP account
We know that TD Waterhouse and Olympia Trust already offer the type of account you will require to successfully navigate this strategy. If you already have a self-directed RRSP account with a brokerage or even have a managed account, you need to take the simple step of transferring funds into a Self-Directed RRSP Mortgage Account .
3. Nobody is looking over your shoulder
As an investor, you would consider this strategy to generate greater than average returns. If you can’t achieve this, why bother? The safer bet would be to park your money in a GIC for guaranteed returns. In order for a property owner to be willing to entertain the idea of paying an interest rate higher than those of tier 1 Canadian banks, there needs to be motivation to do so. This can occur for many reasons, but almost always increases your risk as in investor. We all know that risk and return are inversely related – the greater the return, the more risk you carry with the investment.
4. Pay attention to position on title
When you buy a home and take out a personal mortgage to help pay for it, the bank will always register a restrictive covenant on title. In some cases where a borrower is taking out a second mortgage on the property, the position that a lender has on title is important. RRSP mortgages can be placed on title in a primary, secondary, or even third position. Put simply, this establishes an order that the mortgages are paid back once a property is sold. If your RRSP mortgage is subordinate to a first mortgage, your investment risk increases. This is due to the fact that the primary lender is paid first in the event of a sale. If the property is sold at a reduced value, you may be in a position where your initial RRSP capital is at risk.
The strategy involved in establishing an RRSP mortgage is complex enough that you should seek competent financial and legal advice that can be applied to your particular circumstance. With a little effort, we think you can generate better returns in your RRSP over the long-term.
If you’re looking for more info we cover this topic as part of our seminar content. Watch for or next event in Calgary. All subscribers to our blog will receive advance notice.
