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| Welcome to our February newsletter. In this issue: |
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• Seven costly RRSP mistakes to avoid this year.
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Seven costly RRSP mistakes to avoid this year.
The RRSP deadline is March 1, 2011. Did you wait until the last minute to contribute?
 Many Canadians worry about their retirement savings. They may have suffered major losses in recent years. Some are unsure about what to do next. They don’t want to add to their losses. Yet fear and uncertainty can create other kinds of problems. For instance, it can mean you don’t take action when you should. Or, you might make snap decisions that may hurt your long-term results.
Here are seven common – and simple – RRSP mistakes to watch out for. All can leave you with less money when you retire. All can easily be avoided with a little planning. - Parking your RRSP contributions too long.
Every year, many Canadians “park” their RRSP contributions in cash or money market funds. There is nothing wrong with this in the short-term. It’s better than rushing into a bad investment choice.
Just don’t leave your money there too long. If you do, you could miss out on opportunities to grow your savings faster. For example, it costs Canadians an estimated $300 million to $500 million a year overall in interest income by not shifting their money out of money market funds to higher yielding premium savings accounts at financial institutions.
Tip: If you are investing in mutual funds, don’t rush out and buy funds based on last year’s performance. Anyone can pick a five star fund AFTER the results are in. Instead, find a fund with consistent performance and management style over the long term – at least five years. Also, be sure to check the fees you will pay. See how much your mutual funds really cost using our calculator.
- Spending your tax refund frivolously.
Many people get a lump-sum refund at tax time if they contribute to their RRSP. If you do, don’t think of this as fun money. Instead, put it to work for your financial future.
For instance, it can give you a great start for your next RRSP contribution. Or, consider repaying your loans and credit cards, or paying down your mortgage. It’s a once-a-year opportunity to take action on achieving your top financial goals.
Learn more now about other ways to build up your RRSP savings.
- Missing or delaying your contributions for next year.
As an investor, one of the keys to your success is time. Investing a small amount earlier may help you retire earlier. That’s because you can grow your savings faster through compounding – where you make money by reinvesting your investment gains. So make sure you contribute early and often to your retirement savings.
Tip: Put your savings on autopilot. Ask your financial institution to transfer smaller pre-authorized amounts from your savings account to your RRSP throughout the year. Your savings will grow faster through compound growth. You’ll also be more likely to save more each year. So you’ll have more money growing for you, sheltered from tax.
How often should you contribute to your RRSP?
Find out of you should you borrow to invest.
See how Gary, Kevin and Judith planned their RRSP contributions.
Thinking about missing a contribution? Skipping just one yearly contribution of $5,000 could reduce the value of your RRSP by almost $17,000 at the end of 25 years (assuming a 5% annual rate of return). When you contribute every year, your savings grow tax-free until you take the money out.
Learn more now about where to park your RRSP contribution and about Money Market Funds.
- Dipping into your RRSP savings for cash.
Cashing in part of your RRSP has major tax consequences unless you’re doing so through the Home Buyers Plan or Lifelong Learning Program. Between 10 and 30 per cent of the amount you withdraw will go straight to the Canada Revenue Agency for taxes. Plus, you must report the total cash you receive as income and pay any further tax owing.
In the end, the cash you’ve left to spend may only be half of the amount you took out. So, cash in your RRSPs only as a last resort.
Learn more now about the cost of early withdrawals from your RRSP.
- Having too many RRSPs.
If you spread your RRSP savings across multiple accounts, you may end up paying extra account fees. It can also make it much harder to see the ‘big picture’ when you plan your investments. That makes it difficult to diversify properly to reduce your risk. If you have an adviser, it will be harder for them to fully understand all your holdings.
It also makes it harder to follow how all your investments are doing. So consider consolidating all your RRSPs. It can help you stay on track as you work to build your retirement savings.
Remember: Making your RRSP contribution is just the first step. The steps you take – or don’t take – next have a major impact on the money you will have when you retire. Proper planning is essential. Learn more now about retirement planning strategies.
- Not naming a beneficiary for your RRSP.
Even though RRSPs make up most of many people’s assets, some still do not name a beneficiary. Or, they don’t understand how it will affect the taxes due on their RRSP savings. For instance, your RRSP savings can be transferred tax-free only to your spouse or a dependent child under age 18. In some cases, the same is true for a disabled adult child. Every other beneficiary will have to pay tax.
Learn more now about what happens to your RRSP after your death.
- Missing out on income splitting through a spousal RRSP.
If you have a spouse, the larger earner is likely the one putting more money into RRSPs. To even things out, that person could start saving money in a spousal RRSP. Why is this a good idea?
When you retire, each spouse will draw money from their RRSP and file a separate tax return. If a couple has split its RRSP savings more evenly, each person will be in a lower tax bracket than if the income all came out of one person’s RRSP. For some people, this can save thousands of dollars in taxes each year.
Shifting investment income from a higher income earner to the lower income earner can mean less tax payable if the lower income earner is in a lower tax bracket during retirement.
Tip: Your total RRSP contributions each year must stay within your limit. If your limit is $5,000 next year, then you can split that $5,000 between your own and your spouse’s RRSP. But you cannot contribute more.
Learn more now about spousal RRSPs.
Is an RRSP right for you? Not everyone saves on taxes by putting money in an RRSP. It depends on the taxes you pay today and how that will change after you retire. Another option is to put some of your savings into a Tax-Free Savings Account. To learn more, read this case study: RRSP or TFSA? Tia’s story.
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