RRSP regrets: 5 things to avoid

Ottawa doesn’t exactly shower us with tax breaks, so it’s best to grab what’s available. The Registered Retirement Savings Plan (RRSP) is arguably the best way to shelter savings from the tax man until we retire in a lower tax bracket. But there are times when the lifetime savings plan can present a lifetime of regret. Here are 5 things to avoid.

1. Don’t dip in if you are still working

It’s no coincidence one of the Rs in RRSP is retirement. Ottawa wants you to use it when you retire and penalties are high if you dip in early. Depending on the amount withdrawn, the Canada Revenue Agency imposes withholding taxes of between 10 per cent and 30 per cent right off the top. Withholding taxes are even higher in Quebec. If your income is high, you may be required to pay additional taxes.

To make matters worse, withdrawing money from of an RRSP early takes away the ability for it to grow over time through investments.

The only time early RRSP withdrawals make sense is when you have little or no taxable income, or to borrow to buy a first home or go back to school (see Home Buyer’s Plan or Lifelong Learning Plan).

2. Don’t leave it parked in cash

Many RRSP holders rush to make their annual contributions before the March deadline to get that coveted refund.

Unless instructed otherwise administrators will deposit the funds in a cash account, which earns little to no interest.

Make the most of your RRSP’s ability to grow tax free over a long period of time and invest it.

Better yet, devise a strategy. Talk to a financial advisor about building a diversified portfolio that maximizes gains and limits the risk of losses.

Be sure to ask about all fees up front. Every dollar in his pocket is one less dollar in yours.

3. Don’t over contribute

Too much of anything can be bad and that includes RRSPs.

Minimum withdrawals are enforced when you retire and if you contribute too much, and it grows too large, your money could be taxed in a higher bracket.

Over contributions could also trigger Old Age Security claw backs – payments you are entitled to as a Canadian.

4. Don’t forget to claim it on your income tax return

Things can get crazy at tax time. If you forget to include your RRSP contribution on the appropriate line of your tax return you will not be refunded.

If you make regular contributions keep receipts organized and handy.

Don’t sweat it if you forget, though. RRSP contributions can be carried forward to future years indefinitely. In fact, if you know you will be making more in future years, and taxed in a higher bracket, it might be a good idea to save some or all of that contribution for then.

5. Don’t squander your refund

Let’s face it. Most people contribute to an RRSP for the instant tax refund. But there is a way to turbo-charge your contribution by contributing the refund.

Say you contribute $1,000 at a Federal tax rate of 22 per cent. You will receive a $220 refund.

If you can bite the bullet, or borrow an extra $280 to add to the contribution, you can also get a refund on the refund of $60 to cover the extra amount.

In other words, if you contribute $1,280 at a tax rate of 22 per cent you will receive a $280 refund.

Online RRSP calculators can help determine amounts that apply to you. The refunds grow as the contributions get higher.

If you don’t want to contribute the refund to your RRSP put it in a Tax Free Savings Account (TFSA). You can’t deduct the contribution but you can withdraw the contribution plus any gains without getting taxed.