Registered Retirement Savings Plans (RRSPs) are one of the key tools Canadians use to plan their retirement. While these tax-advantaged accounts offer significant benefits, they also have complex rules and potential pitfalls. Misunderstanding or mismanaging your RRSP can have serious consequences for your financial future.
This article highlights 16 common RRSP mistakes that could potentially derail your retirement plans.
Contributing without considering your tax bracket
RRSP contributions are most beneficial when you’re in a higher tax bracket. Contributing when your income is low might not provide significant tax savings now and could result in higher taxes later. Consider your current and expected future tax brackets when deciding whether to contribute to an RRSP or use other savings vehicles like a TFSA.
Missing the contribution deadline
The RRSP contribution deadline for the previous tax year is typically 60 days after the year-end. Missing this deadline could mean losing out on tax deductions for that year. Mark the deadline on your calendar and plan your contributions in advance.
Over-contributing to your RRSP
Exceeding your RRSP contribution limit can result in a 1% per month penalty tax on the excess amount. This penalty continues until you withdraw the excess or a new contribution room becomes available. Always check your available contribution room using your latest Notice of Assessment.
Withdrawing from your RRSP before retirement
Early withdrawals from your RRSP are subject to withholding tax and are added to your taxable income for the year. This can push you into a higher tax bracket and reduce your retirement savings. Avoid using your RRSP as an emergency fund or for short-term expenses.
Not taking advantage of spousal RRSPs
Spousal RRSPs can help balance retirement income between partners and potentially lower overall taxes in retirement. If one spouse earns significantly more than the other, consider contributing to a spousal RRSP to split income more effectively in retirement.
Holding the wrong investments in your RRSP
Some investments, like dividend-paying Canadian stocks, are better held outside an RRSP due to the preferential tax treatment of Canadian dividends. Consider holding investments that are taxed at the highest rates, like interest-bearing securities in your RRSP.
Neglecting to name a beneficiary
Failing to name a beneficiary for your RRSP can lead to your entire RRSP value being taxed as income in the year of your death. This can result in a large tax bill for your estate. Name a beneficiary, preferably a spouse or financially dependent child, to ensure a smoother transfer of assets and potential tax deferral.
Converting your RRSP to a RRIF too early
You must convert your RRSP to a Registered Retirement Income Fund (RRIF) by the end of the year you turn 71 (you can also buy an annuity or withdraw the cash). Converting too early might force you to make withdrawals before you need the money, potentially pushing you into a higher tax bracket.
Not considering the impact on government benefits
RRSP withdrawals count as income and can affect income-tested government benefits like Old Age Security (OAS). Large RRSP withdrawals in retirement could lead to a clawback of these benefits. Plan your retirement income strategy to minimize the impact on your benefits.
Investing too conservatively
While it’s important to manage risk, investing too conservatively in your RRSP can lead to inadequate growth over time. Consider your risk tolerance and investment timeline, and don’t shy away from growth-oriented investments, especially if retirement is still many years away.
Forgetting about foreign withholding taxes
Some countries impose withholding taxes on dividends paid to foreign investors. In an RRSP, you can’t claim a foreign tax credit for these withholdings. For U.S. stocks, consider holding them in an RRSP to avoid withholding tax, but for other foreign investments, a non-registered account might be more tax-efficient.
Not rebalancing your RRSP regularly
Over time, some investments in your RRSP may grow faster than others, throwing off your target asset allocation. Failing to rebalance regularly can lead to a portfolio that doesn’t match your risk tolerance or investment goals. Review and rebalance your RRSP at least annually.
Ignoring fees
High investment fees can significantly erode your RRSP’s growth over time. Pay attention to the management expense ratios (MERs) of mutual funds or exchange-traded funds (ETFs) in your RRSP. Consider lower-cost options that still meet your investment needs.
Not coordinating RRSP strategy with your spouse
If you’re married or in a common-law relationship, it’s important to coordinate your RRSP strategy with your spouse. This includes considering spousal RRSPs, balancing contributions, and planning for tax-efficient withdrawals in retirement. A coordinated approach can lead to better tax outcomes and more efficient use of your combined retirement savings.
Not understanding the Home Buyers’ Plan (HBP) rules
The HBP allows you to withdraw up to $35,000 from your RRSP to buy your first home, but you must repay this amount over 15 years. Failing to make the required annual repayments results in the unpaid amount being added to your taxable income. Some people forget about these repayments or don’t budget for them, which can lead to unexpected tax bills and reduced retirement savings.
Procrastinating on starting RRSP contributions
The power of compound growth means that starting your RRSP contributions early can significantly impact your retirement savings. Delaying contributions, even by a few years, can result in a much smaller nest egg at retirement. Start contributing as early as possible, even if it’s just a small amount each month.
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