The Registered Retirement Savings Plan (RRSP) is a Canadian savings program that has been helping us prepare for our post-work lives since it was introduced over 60 years ago. If you’re already making contributions to an RRSP, you should congratulate yourself –there’s more than $1 trillion in total unused contribution room in Canada.1
What exactly is an RRSP? A Registered Retirement Savings Plan is a type of investment account that helps you grow your retirement savings. The account is registered with Canada’s federal government and offers some great tax benefits. One of the best benefits is that your contributions to the account (up to your yearly limit) can be deducted from your earned income, which lowers the amount of income tax you pay that year.
Make sure you are getting the most out of your RRSP; here are 5 common mistakes to avoid:
1. Withdrawing early
One of the biggest mistakes that Canadians can make is withdrawing funds from their RRSP before retirement.2 If you withdraw funds early, you lose that contribution room and the tax deferred growth that comes with it. While all withdrawals are subject to withholding tax (the amount that your employer withholds from your income and pays directly to the government) of 10% to 30%3, you’ll likely pay a higher marginal tax (percentage of tax applied to your income based on your tax bracket) as the money withdrawn will be added to your income for the year.
2. Contributing too much
It’s great to plan for your future, but putting too much into your RRSP can be a problem. Over contributions to an RRSP can cost you a penalty of 1% per month on contributions that exceed your RRSP deduction limit by more than $2,000. You can contribute up to 18% of your previous year’s earned income up to a maximum of $27,230 for 2020, plus any unused contribution room from previous years.
If you have additional savings, you can also consider a Tax-Free Savings Account, which offers a cumulative total contribution room of $69,500 for up to the end of 2020.
How do you find out your RRSP deduction limit? It’s on your most recent Notice of Assessment from the Canada Revenue Agency (you can also find it on your online myCRA account).
Unused contribution room can be carried forward indefinitely; contributions to your RRSP can be made until the year in which you turn 71 years and your spousal RRSP until the year in which your spouse turns 71 years of age.
Time is on your side when it comes to contributing to an RRSP – contributing early and on a regular basis can help you build your savings easily and automatically. The best news for those just starting out is that you don’t need a lot of money to make a lot of money. Monthly contributions – boosted by the power of compound growth – can accumulate significantly over time.
4. Being overly risk averse
Depending on how old you are, there may be decades before you reach retirement. While volatility can be stressful, especially when reading news headlines, over longer periods, the variance between the highs and lows shrinks considerably and you’re more likely to come out ahead. Maintaining a longer-term perspective and taking a diversified approach to investing aligned to your risk tolerance and time horizon is often the best approach.
5. Failing to revisit the plan
It’s not enough to open an RRSP and make a lump sum contribution. Each year, you should take the time to evaluate your retirement goal – when you want to stop working and how much annual income you’ll need to do so comfortably – and adjust your plan if needed.