If you are like most Canadians, saving for retirement is a fairly straightforward affair. Perhaps you entrusted a financial advisor to invest your RRSP funds in a mix of stocks, mutual funds and GICs. However, with the rise in popularity of self-directed RRSP accounts, and an ever expanding range of investments products to choose from, many investors looking to maximize their returns might be dipping their toes in less conventional investments.
Variety is good for investors. Having a diverse portfolio can help an investor reduce risk and potentially improve returns. There are, of course, restrictions on what investments you can purchase in your RRSP. As specified under the tax rules and regulations, investments in your RRSP must be "qualified investments." The rules dealing with whether an investment qualifies as such can be quite complex and technical.1 Unfortunately, there is no definitive list setting out each and every qualified investment; rather, the CRA sets them out by category. And as the categories of RRSP eligible investments expand—and as the tax rules and regulations continue to change—it can be quite the challenge for the average investor to know exactly what can or cannot be held in an RRSP.
The consequences of buying a non-qualified investment in your RRSP can be quite severe. Under the tax rules and regulations, you could face a tax of 50% of the fair market value of such non-qualified investments at the time they were acquired or became non-qualified – even though they're held within your RRSP. Fortunately, it's possible to have this tax refunded in certain cases (generally, if you can demonstrate that the investment had been made inadvertently); however, it is best to ensure your investments qualify at the outset. In that regard, what follows is a high-level overview of the some of the major categories of qualified investments:
Money and deposits (such as GICs) with a Canadian bank, trust company, or credit union.
Money denominated in any currency is a qualified investment provided that the fair market value of the "money" does not exceed its stated value as legal tender. Exceptions would include rare coins and other forms of money held for collectible value. In addition, for the more technologically-inclined among us, according to the CRA, digital currencies, such as Bitcoin and Ether, are not considered to be money issued by a government of a country and therefore are not qualified investments.
Securities listed on a designated stock exchange.
Securities are qualified investments where they are listed on a designated stock exchange. This includes Canadian exchanges such as the Canadian National Stock Exchange; the Montreal Exchange; the TSX Venture Exchange; and the Toronto Stock Exchange. Major stock exchanges in the United States (e.g. New York Stock Exchange and the NASDAQ) as well as in Europe and Asia are also considered designated stock exchanges.2 Securities in this category include all types of listed bonds, common or preferred shares as well as units or debt issued by a corporation, limited partnership, exchange traded fund, mutual fund, income trust or REIT. It should be noted that securities traded over-the-counter are generally not qualified investments; however they may qualify if they satisfy certain other qualification conditions.
Warrants and Options.
In addition to warrants and options that are listed on a designated stock exchange, certain unlisted warrants, options and similar rights are eligible so long as the issuer of the warrant, option or right deals at arm's length with each person who is an annuitant or a beneficiary of the RRSP. In addition, the underlying security must itself be a qualified investment and must be a share, unit or debt of the issuer of the right (or a non-arm's length party), or a warrant issued by the issuer (or a non-arm's length party) to acquire such share, unit or debt. In 2005, Ottawa amended the rules to make certain derivatives eligible as qualified investments. Prior to 2005, only call options could be purchased and sold in your RRSP. Now, put options may also be purchased in your RRSP. Thus, purchasing calls (instead of buying stocks), covered call writing3 and purchasing puts (instead of short-selling stocks) are now allowed in RRSPs.
Investment-grade gold and silver bullion, coins, bars, and certificates on such investments are qualified investments. These investments must be acquired either from the producer or issuer of the investment or from a regulated financial institution.
Some common debt obligations that are qualified investments include bonds, debentures, notes, mortgages or similar obligations issued by: the Government of Canada (e.g. Canada Savings Bonds); a province or municipality in Canada; or a federal or provincial Crown corporation. Debt obligations issued by a corporation, trust or limited partnership listed on a designated stock exchange are also qualified investments, assuming that certain conditions are met. Bankers' acceptances, commercial paper and debt that has an investment grade rating and that was issued as part of a minimum $25 million issuance. It should be noted that strip bonds or coupons are generally considered to be qualified investments, provided the original bond itself is a qualified investment.
While real estate itself is not a qualified investment, a loan secured by a mortgage in respect of Canadian real estate does qualify. The rules permit such "private mortgages" to be made on an arm's length basis or non-arm's length basis and the requirements between the two are different. In a nutshell, with an arm's length mortgage, you would use the money in your RRSP to advance a mortgage loan to a third party that you deal with at arm's length (i.e. they are not related to you by blood marriage or adoption) and the value of the property must be sufficient to cover the full amount of the principal and interest outstanding under the loan (ignoring any decline in the fair market value of the property after the mortgage was given). Alternatively, under a non-arm's length mortgage, the borrower is also the annuitant – in other words, you could hold your own (or a family member's) mortgage in your RRSP. In order for a non-arm's length mortgage to qualify, the mortgage must be insured and the interest rate and terms must reflect market rates and terms in effect when the loan was advanced.
1 when selling call options in an RRSP, the underlying security must be held in the RRSP.
2 The full list of designated stock exchanges is quite extensive and is published on the Department of Finance Canada website: http://www.fin.gc.ca/act/fim-imf/dse-bvd-eng.asp.
3 These rules and restrictions also apply to investments held in other registered plans such as RRIFs, RDSPs, TFSAs and RESPs.
Previously published in August/September 2017 edition of CannaInvestor magazine.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.