When it comes to saving for retirement, Registered Retirement Savings Plans (RRSPs) are among the most effective tools available to Canadians. However, even if you’re actively planning for your golden years, you can unfortunately still make some poor decisions along the way. Here are seven RRSP mistakes you’ll want to avoid.
Mistake #1: Not knowing how an RRSP works
Understanding how your RRSP works is paramount to avoiding mistakes. For every dollar you contribute, your taxable income is reduced by an equal amount. For example, if you earned $100,000 and contributed $15,000 to your RRSP, your taxable income for the year would be $85,000. Since you would have likely already paid income tax on the $15,000, you’d probably get that returned to you when you file your taxes.
Additionally, any money invested within your RRSP is tax-free until you withdraw it. Since most people will only withdraw funds when they’re retired and in a lower tax bracket, they’ll pay less tax overall.
Mistake #2: Ignoring your TFSA or FHSA
Having an RRSP is beneficial, but you shouldn’t overlook your Tax-Free Savings Account (TFSA) or Tax-Free First Home Savings Account (FHSA) because they also offer advantages.
With your TFSA, you don’t get a tax break, but all gains are completely tax-free when they’re withdrawn. This account is suitable for individuals in a lower tax bracket, as RRSP contributions may not provide a significant tax break.
FHSAs are even more appealing because they offer the advantages of both an RRSP and TFSA. Your contributions reduce your taxable income, and any gains grow tax-free. The catch is, once you open an account, you have 15 years to buy your first home. But even if you don’t, those funds can be transferred into your RRSP.
Mistake #3: Waiting until February to contribute
Many people wait until February to contribute to their RRSP since it’s the annual deadline. While it’s great that you’ve put in this extra money, you’ve missed out on months of potential tax-deferred growth. Additionally, these last-minute contributions may lead to impulse investment decisions or leaving things in cash.
A better approach would be to set up automatic monthly contributions, allowing your money more time to grow. Ensure these transfers are also set to automatically invest, so you don’t miss out on any gains.
Mistake #4: Not knowing your investment timeline
Although RRSPs are clearly designed for long-term retirement savings, some individuals make investment decisions that are better suited for short-term needs. Generally, you should make investment choices based on when you’ll need the money.
For example, someone in their early 20s investing for their retirement would likely benefit most from investing in products with higher growth potential. Even if there’s a dip in the markets, they’ll still have time to recover.
On the other hand, anyone just a few years away from retirement might prefer their portfolio to be more conservative. The last thing they want is to see their funds decline before they need to start withdrawing their funds.
Mistake #5: Leaving contributions in cash
Contributing cash to your RRSP is a good start, but leaving it idle or in a high-interest savings account won’t benefit you in the long run because it has limited growth potential. An RRSP is simply an account; once your money is there, you can buy different investment products such as mutual funds, exchange-traded funds (ETFs), individual stocks, and more.
You should invest in products that match your timeline and risk profile. If you’re unsure about your options, consult an investment advisor.
Mistake #6: Overcontributing
Contribution room is based on 18% of your previous year’s income, up to a limit set by the Canada Revenue Agency (CRA) each year. Any unused room gets carried over indefinitely. You can find your contribution limit in your CRA My Account or your latest Notice of Assessment.
Over-contributions can happen when your employer has an RRSP matching plan or the sum of your automatic transfers exceeds your yearly limit. Paying attention to your contribution limit is essential since a 1% monthly fee applies for over-contributions (with a $2,000 buffer).
Mistake #7: Withdrawing funds early
If you withdraw funds early, a withholding tax is applied immediately, and you might have to pay additional taxes when you file your tax return. Also, any amount withdrawn from your RRSP is permanently lost. Some exceptions do apply, such as those using the Home Buyers’ Plan (HBP) and Lifelong Learning Plan (LLP), which allow tax-free withdrawals. However, these funds must be repaid eventually.
Unless it’s for an emergency, you’ll want to avoid withdrawing from your RRSP.
Final thoughts
Avoiding these RRSP mistakes is easy if you take the time to understand the rules and know the available options. With some planning, the money invested in your RRSP can help you reach your retirement goals.
Barry Choi is a Toronto-based personal finance and travel expert who frequently makes media appearances. His blog
Money We Have is one of Canada’s most trusted sources when it comes to money and travel. As a completely self-taught, do-it-yourself investor with no formal training, he makes money easy to understand for all Canadians. His specialties include personal finance, budget travel, millennial money, credit cards, and trending destinations.