Episode #35: 5 RRSP Mistakes To Avoid In Canada
In today’s episode we’re going full Canadian finances and talking RRSP’s. To start with though, in case you’re unclear on what an RRSP is (you’re absolutely not alone in this) we’ll start with the basics.
What is an RRSP?
RRSP stands for Registered Retirement Savings Plan. It is a Canadian, tax advantaged saving and investing account account. Most of us who live and earn money and pay taxes here in Canada should be taking advantage of using this account. You can use them to reduce your tax burden, and save and invest money for retirement while taking advantage of tax exemptions that will help this money grow.
RRSP’s are a great tool to use, but a lot of people shy away from using them because ,at first glance they can seem a little confusing. And if you’ve been feeling that way, it’s totally okay! This is not something we’re ever formally taught in school, and a lot of people don’t like talking about their money and their savings, so it doesn’t come up in everyday conversation. As a result, we don’t naturally get an understanding of how to use an RRSP without specifically seeking out and learning that information ourselves.
So, today I thought I’d help break down that first barrier to entry by identifying 5 of the most common mistakes people make with their RRSP, so that you can avoid these same pitfalls. If you can avoid making just these 5 mistakes, then you can sleep soundly knowing that you’re using your RRSP the right way, and you have nothing to worry about. So, if you’ve been feeling lost everytime you hear the word RRSP, and want to start saving and investing money for your future but don’t entirely know how to use your RRSP then make sure you read this whole episode, because I’ve got you covered!
Common RRSP Mistake #1: Not contributing to the RRSP before the cut off date each year.
Mistake #1 that people make with their RRSP is not putting in their contribution before the cutoff date of March 1st. You’re allowed to contribute to your RRSP anytime, BUT when you make your contribution before the cutoff date then you can use that contribution as a write off against your taxes for that year. This means you can use it to lower your taxable income, which means you pay less tax, which means that you end up being able to keep more money in your own pockets, and who doesn’t like that?!
Contributing to your RRSP is one of the easiest ways to lower your taxable income. If you already have the ability to set aside that money as savings each year then it’s a great move to put it into your RRSP. This account was essentially designed as an incentive for Canadians to save for their retirement. The government wants you to do that, so they’re offering a literal cash incentive of being able to write it off against your taxes.
So, make sure you contribute to your RRSP before March 1st. Put that date in your calendar. Make sure you’re contributing to your rrsp by the end of february at the latest, and then you can use it to pay less tax when you file in April.
Common RRSP Mistake #2: Not Knowing Your Individual Contribution Limit.
You’re not allowed to put just any amount of money you want into your RRSP and write it off against your taxes. You’re also not limited by your employer match if that’s something that you have. You’re allowed to contribute 18% of your previous year’s income to your RRSP. This means that if last year you earned $100,000.00, then this year you’re allowed to contribute $18,000.00 to that account. If you contribute more than the allotted 18% there will be a financial penalty. Conversely, many people will under-contribute to their RRSP because they’re just contributing the percentage allotted for their employer match. If your employer matches you 3% for RRSP contributions, you’re allowed to contribute more than that 3%, they just won’t contribute more than that. If you have the ability to, you should be working towards contributing the full 18%, because tax write offs are great and it’s a great way to save and invest for your retirement!
If you’re ever unsure about exactly how much you’re allowed to contribute, just pull up a copy of your Notice of Assessment from the CRA for your previous year’s taxes. It will tell you exactly how much you’re allowed to contribute this year. They make it easy to find, on your NOA it says ‘RRSP contribution limit’ and then a number beside it. This is how much you’re allowed to contribute to your RRSP this year, based on your income last year.
Common RRSP Mistake #3: Forgetting To Invest The Money You Contribute To Your RRSP.
Don’t feel bad if you’ve been confused about this, you are certainly not alone! An RRSP is an investing account, but it’s not an investment. RRSP is just the name of the account, and once you’ve contributed money to that account you need to buy investments with it. Just letting the money sit there, maybe earning a basic interest rate from the bank if you’re lucky, won’t do you much good. RRSP’s are designed to promote a long term ‘buy and hold’ investment strategy, because you shouldn’t be planning on accessing that money anytime soon anyways. You’ll actually be penalized for taking money out of the account early.
It’s designed to be the perfect place to buy index funds, or mutual funds, and then sit on them for long periods of time to let that money grow. If you just put that money into your RRSP and never invest it , it’s just going to lose value over time as inflation rises and the value of your dollar decreases. The account won’t be working and helping you grow wealth the way it’s designed to do. So, the RRSP is not the investment, it’s the account you put money into that you then buy investments in.
Common RRSP Mistake #4: Not Naming A Beneficiary
You’re going to contribute and grow a lot of money in this account over the course of your lifetime, and should something happen to you before you get to access that money, you can choose who the money goes to. Now if you already have a will that you’re happy with, you can just name your estate as your beneficiary, and it will all get divided up according to your will. But many young people don’t have a will yet, while they do have a specific person who they want to benefit from the RRSP. If this is your situation, then you need to name a beneficiary and keep that updated throughout your life. For example, should your relationship with a person change, fie: getting remarried, you’ll probably want to change your beneficiary to be your new spouse instead of your previous spouse. Or, if you have kids from your previous marriage, then maybe you want to make sure it goes to them. There are so many different ways of doing this. The point is to be aware that this is a choice you can make when you do the paperwork to open your RRSP, and that it might be something you want to update over the course of your life.
Common RRSP Mistake #5: Contributing Money That You’re Going To Need
The whole idea with your RRSP account is that you start contributing and investing when you’re young, and you don’t touch that account until you’re retirement aged and can access it without penalty. You should never contribute money to your RRSP that you expect to need access to before you’re retired. If you’re looking for a place to save money for a downpayment, then an RRSP is not the best place to save it. As a caveat to this, there is a first time home buyers plan that allows you to withdraw some money from your RRSP, but there are limitations to this, so make sure you understand them before deciding to go this route.
If you put money into your RRSP account and then take it out again for an emergency or a big purchase, then you will be penalized on that money and you never get to make it back up again. This account is really for long term investing and saving only. The rule of thumb is to make sure that you’ve taken care of your basic financial needs before you contribute money to your RRSP because you don’t want to take it back out again.
Making sure you have your emergency account fully funded first is one of the best ways to make sure you don’t ever end up in a pinch and need to access that RRSP money. So, before you start contributing and investing, make sure your emergency fund is topped up, your basic life needs are taken care of, and you’re not carrying any high interest consumer debt. The one exception to this you can consider is if you’re offered an employer match for RRSP contributions, then you should absolutely be taking advantage of this because it can end up being a lot of free money over the course of your working life that you’re otherwise leaving on the table.
So, to wrap up, if you just manage to avoid these 5 common RRSP mistakes, then you can feel pretty confident that you’re using your RRSP properly, responsibility, and taking good care of your future. If you just avoid these pitfalls, you’re doing crazystupid well, and you’ll be amazed by how much wealth you can accumulate for your retirement just by using your RRSP properly.
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