The RRSP is a really remarkable investment vehicle. People in other nations drool over its tax benefits and wonder why more of us don't take advantage of it. A recent article in Forbes.com (headlined "Canadians eschew billions in free money") pointed out that, despite the immediate tax break and the tax-free compounding of interest in RRSPs, Canadians have only contributed seven per cent of the allowable amount. "The government offers them billions of dollars of free money and they turn their back on it," the author marvelled.

Goodness knows the RRSP industry tries everything to get us to make those contributions. The annual barrage of RRSP-related advertising is well underway and the RRSP forces are in blitz mode, trying to persuade us that they — the financial planning firms, the mutual fund companies, the discount brokers, the banks, the insurance companies — are the ones who can best nurture your precious retirement money (and reap the commissions in the process).

So what are you going to do this year? For those who have yet to decide on what move to make (if any), we provide the nuts and bolts, and some suggestions on what's become an annual rite of financial passage for millions of Canadians.

Why should I 'RRSP'?

The RRSP is really nothing more than a special kind of box. It's designed to hold investments in a registered account so they can build tax-free until they're withdrawn. You can have as many RRSPs as you want, although it's better to have fewer for ease of management and to minimize fees.

Since contributions are tax-deductible, they'll be more valuable to those with higher incomes. Once inside the tax-sheltered environment, the investments can grow faster than they would outside an RRSP, where there would be a tax on gains.

You can put your money into a wide variety of investments — GICs, mutual funds, bonds, exchange-traded funds (which track market indices like the S&P;/TSX 60 index), mortgage-backed securities, stocks, and labour-sponsored funds. Thanks to the 2005 federal budget, you can even invest in gold and silver bullion and bars. The old foreign-content rule, which used to limit the amount of money you could put into foreign investments, was also scrapped in the 2005 budget.

To hold some kinds of investments, you'll need to have a self-directed RRSP. That doesn't mean you have to manage everything yourself. It's just a name for an RRSP that can hold multiple kinds of investments — a good way to diversify your investments and lower risk.

If you don't have cash to make a contribution, you can arrange a contribution-in-kind. If you hold securities or Canada Savings Bonds outside your RRSP and don't want to sell them, you can put them directly into your RRSP and get a tax deduction for their current value. Note that if the security has increased in value from when you bought it, you must declare a capital gain. But if it's gone down in value, you can't claim a capital loss.

Financial experts always advise people to automatically pay yourself first. In other words, it's easier to put $200 a month into an RRSP than to come up with $2,400 once a year. Monthly saving also allows you to dollar-cost-average your purchases — the same $200 will buy more units of a mutual fund when unit prices are low, and fewer units when prices are high.

You can continue to contribute to an RRSP until the end of the year in which you turn 69, provided you still have earned income. At that time, you must convert your RRSP into a Registered Retirement Income Fund (the most popular option), buy an annuity, or withdraw it in cash (generally not a good idea as you'll pay tax on the whole amount and won't have a retirement income).

Some people have set up spousal RRSPs to allow them to better split their income during retirement. With spousal RRSPs, the higher-income spouse makes a contribution to the other spouse's RRSP. The contributor gets the tax deduction, but the money is now owned by the other spouse. So when the money is withdrawn from the spousal RRSP, it's taxed at the lower-income spouse's rate. In October 2006, Ottawa announced that senior citizens will be able to split their retirement incomes as of the 2007 tax year. There are some restrictions on what kind of income can be split, and the rules are not as liberal if the couples are under the age of 65, so some couples may want to continue with their spousal RRSPs.

As to what RRSP investment to choose, you may want to consult an investment advisor. If you don't have a company pension plan, you may want to be more conservative. If you're not far from retirement, you may also want to be more conservative. Be sure you know what your risk tolerance is.

If you want to find a financial planner, the Financial Advisers Association of Canada has a useful list of 33 questions to ask a prospective adviser.

What's the deadline?

There is none. Well, that's a bit of a trick question. You can make a contribution at any time. The only RRSP deadline you face is if you want the tax break applied to your 2006 income. In that case, the deadline is midnight, Thursday, March 1. But you can always carry forward unused RRSP contribution room to next year, or the year after that, and so on.

The thing about an annual carry-forward, of course, is that they can quickly mushroom into a mountain of room that will stay unused unless you win a lottery or get an inheritance. If you can't muster $2,000 this year, will you be able to find $4,000 next year, or $6,000 the year after that?

One way to contribute more to your RRSP is by borrowing the money. For those with a large amount of contribution room, some banks offer catch-up loans of up to $50,000 over 10 years. Check to see if this is appropriate for you.

How much can I contribute?

For the 2006 tax year, people can contribute up to 18 per cent of their earned income from the previous year, up to a maximum of $18,000.

But the contribution calculation isn't that simple. From that figure, you must subtract your pension adjustment (PA). If you're a member of a pension plan at work, you'll have a pension adjustment. This amount takes into account the money you and/or your company contributed to an employer-sponsored pension plan. Your T4 slip records the pension adjustment figure.

To this figure, you must then add the total carry-forward of unused RRSP contribution room since 1991. For some taxpayers who haven't been stuffing their RRSPs, this can amount to more than $100,000.

There's an easy way to arrive at this figure without doing all the calculations. Just check the Notice of Assessment you got from the Canada Revenue Agency last year, or phone the tax department's T.I.P.S. line at 1-800-267-6999. You will be asked to provide your social insurance number, your month and year of birth, and the total income you reported on line 150 of your 2005 return.

While there seems to be enormous pressure for everyone to contribute to RRSPs, there may well be a better way to use your money. For those with a lot of high-interest credit-card debt, it may be better to pay that off first.

Are RRSPs only for retirement?

While RRSP stands for Registered Retirement Savings Plan, the government has brought in two provisions that allow Canadians to access RRSP money for reasons other than their golden years.

The Home Buyers Plan (HBP) has been enormously popular in Canada, with almost 1.4 million people taking advantage of it as of 2004. Since 1992, more than $14 billion has been withdrawn. As long as the money is used to buy a qualifying home, no tax is paid on the withdrawal. The catch is that the money must be repaid to your RRSP over the next 15 years or the minimum annual payment will be added to your income and you will pay tax on that. And the repayment is not tax-deductible (you got the tax break the first time you put in the money).

The full rules are complex, so check with the Canada Revenue Agency and your financial adviser.

The Lifelong Learning Plan (LLP) allows Canadians to pull up to $20,000 from their RRSPs to head back to school. The withdrawals can be a maximum of $10,000 in any one year and can be spread over four years. Repayment is on a 10-year schedule. Again, familiarize yourself with the rules and limitations and seek financial advice before doing anything. About 49,000 people have withdrawn $363 million since the LLP began in 1999.

Financial experts also point out that by raiding your RRSP for either of these plans, you lose much of the tax-free compound interest you could have made on that money, so you might want to repay the money quicker than the prescribed schedules.

Recent figures show that growing numbers of Canadians are raiding their RRSPs long before retirement. Often, the reasons for early dipping have nothing to do with buying a home or going back to school. Some people set up an RRSP and collapse it a few years down the road to finance a year of travel. They reason that they got the tax break when they made the contribution, and then will pay less tax on the withdrawal, assuming they have little or no other income that year. But experts point out that this kind of withdrawal, unlike those made under the HBP or LLP, cannot be made up in future years. Those contributions, and the gains they would have earned, will be lost forever.

Avoiding the 'cat food' retirement

There was a time when financial institutions used to scare people into making RRSP contributions by showing how much they'd need to save to have a secure retirement. The problem was, the amounts were so large that some people threw up their hands and said, "Why bother?"

The experts point out that anything saved is better than nothing. If you want to have something more than a subsistence retirement (retirement benefits from the Canada Pension Plan and the Old Age Security program), then that will require some kind of saving. RRSPs are not the only way of saving for retirement, of course. But for most Canadians, they're the best way.

Trying to figure out if you're on track for the "cat food" retirement is a lot easier these days. Your adviser can provide a detailed projection of where you're heading. If he/she can't provide this, you should find another adviser.

You can also check out some of the many retirement calculators on the internet. CBC.ca has a special in depth series on retirement that addresses the "How much is enough?" question. It also looks at the changing nature of retirement and features one of the best interactive retirement calculators we've found.

Retirement becomes a lot easier to afford if you've paid off your mortgage, or if you have a pension plan at work, especially an indexed one that provides guaranteed benefits. But 60 per cent of Canadian workers don't have employer-sponsored pension plans. For those with no retirement income except government benefits, RRSPs and additional saving will make a huge lifestyle difference.

Those on very low incomes should also be aware that RRIF payouts after an RRSP has matured are fully taxable. Those payments may result in clawbacks of the Guaranteed Income Supplement given to low-income seniors, so RRSPs may not be the best choice for those at the lower end of the income spectrum.

Those with retirement incomes above $62,000 should also be aware that Old Age Security benefits begin to be clawed back at that level. Financial advisers often suggest that those expecting a healthy retirement income put money in non-registered investments, as dividend income and capital gains are taxed more favourably than RRIF income.