Are YOU Making These 5 Catastrophic RRSP Mistakes?

Preparing for RRSP season? Here are some expert tips on what to avoid when dealing with your RRSPs.

If you’re considering putting money into a registered retirement savings plan (RRSP) before the yearly deadline, there are important things to know. The deadline, which falls on February 29 in 2024, is your final opportunity to add money that reduces your taxable income. This can potentially lower the amount of tax you owe from the previous year.

Aside from tax benefits, RRSPs offer the advantage of tax deferral. This means any investments you hold within your RRSP can grow without being taxed until you take that money out.

Although investing in RRSPs seems straightforward, mistakes can occur. But there are ways to prevent these issues or catch them before they become problematic.

Here are some tips to help you avoid the 5 most common mistakes made with RRSPs.

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Solely depositing cash in your RRSP

Did you realize that your RRSP isn’t limited to cash? It can hold various investments like stocks, guaranteed investment certificates (GICs), mutual funds, bonds, and more.

RRSPs grow without being taxed until withdrawal. Investing the money allows it to grow more over time. BUT! Here’s a typical situation: rushing to meet the RRSP contribution deadline, you deposit cash but fail to actually invest it due to life getting busy. UGH!

If time is short or you lack a strategy, you might leave your contributions as cash. In such cases, seeking advice from an investment advisor, portfolio manager can assist in devising a plan to invest your assets wisely.

Withdrawing funds prematurely

Pulling money out of your RRSP before retirement for expenses or major purchases can have enduring effects. Firstly, you’re sacrificing the tax-deferred growth that your money would have accumulated within the plan.

Moreover, you’ll encounter a dual tax impact. The initial hit occurs upon withdrawal, subjecting you to immediate withholding tax.

Let’s delve into the actual figures to understand the impact more clearly.

he withholding tax rates for RRSP withdrawals vary based on the amount withdrawn and differ between provinces (except Quebec) and Quebec specifically. Here’s a breakdown:

For all provinces except Quebec:

• For the first $5,000 withdrawn: 10%
• For amounts between $5,000 and $15,000: 20%
• For withdrawals over $15,000: 30%

For Quebec:

• For the first $5,000 withdrawn: 5% federal + 15% provincial on a single withdrawal
• For amounts between $5,000 and $15,000: 10% federal + 15% provincial on a single withdrawal
• For withdrawals over $15,000: 15% federal + 15% provincial on a single withdrawal

The second consequence of early RRSP withdrawals is the potential increase in taxes owed. Withdrawn RRSP funds are considered income by the government, potentially pushing you into a higher tax bracket.

For instance, if your marginal tax rate is 35% and you withdrew money from your RRSP at a 10% withholding tax rate, you would still owe 25% in taxes.

This is why investment advisors or portfolio managers typically advise against withdrawing from your RRSP except as a last resort.

However, there are ways to avoid the tax impact on early RRSP withdrawals. These include utilizing the Home Buyers’ Plan or the Lifelong Learning Plan. These programs enable you to borrow funds from your RRSP for the purchase of your first home or eligible post-secondary education. Nevertheless, it’s essential to repay the borrowed amount within a specific timeframe.

Overcontributing to Your RRSP

You’re allowed to contribute up to 18% of your previous year’s earned income to your RRSP, subject to a maximum amount set annually. Additionally, you can carry forward unused room from previous years, which the Canada Revenue Agency (CRA) details precisely in your notice of assessment.

HELPFUL HINT! You should take the time to SEND YOUR NOTICE OF ASSESSMENT to your advisor so they know what your contribution room is for the next year!

Despite this flexibility, many individuals occasionally go beyond their contribution limits. This typically happens when people have company pension plans or deferred profit-sharing plans (DPSPs).

Contributing to a defined-benefit (DB) or defined-contribution (DC) pension decreases your RRSP contribution limit. The contributions made to a DB or DC pension, as well as to a DPSP (even though it’s not technically a pension), are represented as a pension adjustment in box 52 on your T4 slip. Often, those who over-contribute to their RRSPs may have a pension or DPSP without realizing that these reduce their available RRSP room.

It’s also essential to know that the CRA allows a lifetime over-contribution buffer of $2,000 without incurring penalties. This provision is designed to account for potential errors, such as those stemming from a pension adjustment.

Splurging Instead of Reinvesting Your Tax Refund

Contributing to your RRSP might lead to a tax refund. If you reinvest this money back into your RRSP without exceeding your contribution limits, you can initiate a beneficial growth cycle for your retirement savings. This strategy leverages the power of compounding, where you earn returns not only on your initial investment but also on the returns generated. This compounding effect translates to more money in your account over the long haul.

However, if you opt to spend your tax refund rather than reinvesting it, you’ll miss out on this excellent opportunity for your excess retirement savings to grow.

Misinterpreting RRSP Succession Rules

A common mistake arises when individuals designate an adult child as their RRSP beneficiary while having a living spouse or common-law partner.

But what happens if you pass away without a living spouse or partner and leave your RRSP to your estate? You won’t be able to avoid the tax obligations. The Canada Revenue Agency (CRA) will add the fair market value of the assets held in your RRSP (at the time of passing) to your income in the year of your death. This can lead to a substantial tax bill for your estate, potentially reducing the value for your heirs. Yet, this tax can be deferred (meaning it’s not payable immediately) if you passed away leaving:

• A financially dependent child or grandchild under 18, or
• A financially dependent, physically or mentally incapacitated child or grandchild of any age.

Despite these drawbacks, it’s crucial not to entirely avoid RRSPs. The key is to perceive your RRSP as a tool for sustaining yourself in retirement rather than solely for leaving a legacy.

It’s important to keep in mind that for the 2023 tax year, the RRSP deadline falls on February 29, 2024. The Canada Revenue Agency (CRA) permits contributions for the previous tax year for up to 60 days after the year-end.

If you haven’t started contributing to an RRSP yet, it might be a great idea to set one up now. This move can kickstart the growth of your retirement savings, giving your nest egg a valuable head start.

Have Questions? Contact us

We’ve assisted our clients through every stage of life. Even when you’re not aware that something might impact your financial future, it likely will to some extent. Engaging in a conversation with your investment advisor about any financial changes is an excellent approach to keeping your financial goals in focus.

If you’re in the process of planning a cross-border move or have already relocated from the US to Canada and seek assistance in streamlining and enhancing your financial strategies, we’re here to help. We have the expertise in cross-border wealth management. Don’t hesitate to reach out to us — we’re committed to providing tailored solutions for your cross-border financial needs.

For more information or to connect with me, you can reach out via email at macekadmin@iaprivatewealth.ca or get to know me better by exploring my engaging video content on YouTube https://www.youtube.com/@joemacek.

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Don’t hesitate to reach out today at 1–888–324–4259 to discover more about how we can help you achieve your investment milestones.

Joe A. Macek, FMA, CIM, DMS, FCSI

Investment Advisor, Portfolio Manager

iA Private Wealth | iA Private Wealth USA

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Email: macekadmin@iaprivatewealth.ca

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