Registered retirement savings plans (RRSPs) are once again the talk of the break room for millions of Canadians who contribute to them.
It’s the tax refund that usually gets the conversation going but it’s the March 3 deadline that gives it a sense of urgency.
Unfortunately, the rush to put a contribution together often clouds a basic understanding of what an RRSP really is. To get an idea is what an RRSP isn’t, here are eight common flubs that could hinder your retirement portfolio.
1. You need to make your RRSP contribution before March 3
Wrong. You only need to make your contribution before March 3 if you want to deduct the full amount from your 2024 taxable income. You can contribute any time and claim it in future years.
2. You need to invest your contribution before March 3 to claim it for 2024
Wrong again. You can park it in cash before the deadline, claim it on your 2024 tax return, and decide how to invest it whenever you want. Don’t wait too long, though. As inflation takes hold, it’s best to have it invested in something that grows.
3. RRSPs are a tax exemption
Super wrong. Tax exemptions are forever. RRSPs provide a deferral, or shelter, from taxation until funds are withdrawn; ideally in retirement when you are taxed at a low rate.
4. You cannot withdraw from you RRSP until you retire
Not true. It might make sense to withdraw from your RRSP in years when your income is severely reduced and you are being taxed at a low marginal rate anyway. Withdrawals before 65 years of age are subject to a withholding tax at the source but any excess amount will be returned when you file that year’s tax return.
Early withdraws can also be made with no tax consequences for first time home purchases or continuing education provided the funds are returned within a specific period of time.
5. The tax refund from your contribution is a windfall
Not really. It’s just Ottawa returning part of what you already paid during the year through payroll deductions from your employer. Actually, RRSPs only provide an investment advantage if the refund is reinvested and tax savings can compound over time.
6. You should contribute as much as possible
Possibly a bad idea. Even if you don’t contribute the maximum allowable amount, an RRSP that grows too large could put you at a high tax rate when it comes time to withdraw. Eventually, Ottawa will force you to make minimum withdrawals. If the amount is too high, you could face Old Age Security (OAS) benefit clawbacks as well.
7. You should always contribute something to your RRSP
Not always. Despite what the finance industry tells you, there are times when your dollars would be better spent elsewhere. One stark example is high interest debt like credit card balances, which could top 20 per cent, or even student and consumer debt at double-digit rates.
There are no RRSP investments that could guarantee returns close to that even with the tax advantages. If you’re one of the many Canadians struggling with record amounts of debt, pay it down.
If your debt is under control but your income and marginal tax rate is low, a better option could be investing in a tax-free savings account (TFSA), which cannot be deducted from income but is not taxed when it is withdrawn. Save that RRSP space for higher income years.
8. You can only hold mutual funds offered by your bank
Wrong. The bank representative that sells you a mutual fund to put in your RRSP will probably fail to mention that Canada has a thriving investment industry with better performing investment options at a lower cost.
Most Canadians invest for retirement through mutual funds and most mutual funds are purchased through their financial institutions. “Advisors” are often mutual fund vendors, and their advice is often to purchase the mutual funds that pay them the best commissions.
Most offer prepackaged portfolios of mutual funds for diversification but RRSPs can be invested in just about anything – stocks, bonds, some options, exchange traded funds (ETFs) – which almost always carry lower fees, so shop around.
