10 RRSP Mistakes and How to Avoid them

Over 6 million tax filers reported making RRSP contributions for the 2018 tax year. Despite being around for long and its popularity, there are still some common mistakes that Canadians make when it comes to their RRSP.

Below are 10 common RRSP mistakes you should be aware of and avoid:

Common RRSP Mistakes

1. Over-contributing to your RRSP

The gravest mistake you can make with an RRSP is contributing more than your contribution limit for the year.

For the 2020 tax year, the annual limit is 18% of your 2019 income up to a maximum of $27,230. You may also contribute or use any unused contribution room from previous years.

Going above this limit can quickly become costly. CRA allows a lifetime over-contribution limit of $2,000 to account for errors. That is a lot of room for error but unfortunately, people still go over the buffer. After that, you may have to pay a tax of 1% per month on the excess contribution

To avoid this mistake, make sure you’re monitoring and tracking all your contributions throughout the year. And remember that your pension contributions also reduce your annual limit.

How do you know your RRSP contribution room? You can get the information from your most recent Notice of Assessment (NOA) or login to your myCRA account to get the limit.

And if you go above the limit, CRA may be able to cancel or waive the tax if you can prove the excess contribution is due to a reasonable error and show you are taking reasonable steps to correct it.

2. Waiting till the deadline to contribute

Every year around January to February, there are many RRSP adverts from financial institutions encouraging Canadians to contribute to their RRSP before the deadline. The RRSP deadline for the 2020 tax year is March 1st, 2021.

All good, but you should not be waiting till the deadline to contribute. The earlier you contribute to your RRSP, the earlier you can put your money to work and take advantage of tax-free compounding.

Also, the rush to beat the deadline leaves little room for you to consider your investment strategy and make an informed decision about the most tax-efficient use of your savings.

To avoid this, make regular contributions all through the year. Even better, set up pre-authorized transfers from your checking account to the RRSP, to go out after each paycheck.

You may even be able to arrange for the contribution to be deducted at source before you receive your paycheck.

If your account is self-directed, just remember to invest the funds once the transfer hits your account.

3. Making early withdrawals

One of the misconceptions of RRSPs is that you can’t withdraw from it till retirement. Fortunately, this is not true. It is your money and you can withdraw it whenever you want.

The bad news is, there could be some adverse tax impacts.

Unlike TFSA, RRSP withdrawals always have a tax impact. Even when you withdraw at retirement when you may be at a lower tax bracket, the amount withdrawn is added to your taxable income for that year and taxed.

If you withdraw before then, the amount withdrawn will be subject to withholding tax. The withholding tax varies depending on the amounts withdrawn, the higher the amount the higher the rate.

Any withdrawal of $5,000 or below attracts a rate of 10%; between $5,001 and $15,000, the withholding tax rate is 20%; and it rises to 30% for withdrawals above $15,000.

WithdrawalAll Provinces (Except Quebec)Quebec
$5,000 and below10%20%
$5,001 to $15,00020%25%
Above $15,00030%30%

The withholding tax is different for Quebec residents: it is 15% for all withdrawal amounts plus the federal withholding tax of 5%, 10% and 15% for the three withdrawal brackets indicated above.

What if you decide to make a series of smaller withdrawals to avoid the higher withholding tax rate? If it appears that the series of withdrawals is being made to pay lower tax, the CRA’s position is that the rate applicable to the total or lump sum should be used.

But this is not the final tax impact. When you file your tax, the withdrawal is added to your tax and the actual tax liability for the year determined. So, depending on your income from other sources, if your marginal tax rate is higher than the withholding tax, you’ll be on the hook for more taxes. Otherwise, you’ll get a refund for the excess tax withheld.

Early Withdrawals without penalty

However, you can withdraw early from your RRSP under the Home Buyer’s Plan (HBP) or the Lifelong Learning Plan (LLP). If you’re a first-time home-buyer, HBP lets you borrow up to $35,000 from your RRSP. The LLP allows you to take up to $20,000 out for you or your spouse’s post-secondary education. The only catch is the money must be paid back within the specified time: 15 and 10 years for HBP and LLP, respectively.

Besides the withholding tax you pay when you withdraw from your RRSP early, there are other consequences to consider:

  • You permanently lose your contribution room: Unlike TFSA where withdrawals can be re-contributed in the following year, you permanently lose your RRSP contribution room when you withdraw from it. The exceptions are withdrawals under the HBP and LLP programs
  • You lose the tax-sheltered compounding effect: This isn’t always obvious, but it has a considerable and disproportionate impact on your long-term investment value. Once a withdrawal is made, with no opportunity to re-contribute it, you lose the ability to compound both the principal and the income it would have earned, over the long term.

Therefore, it is important to have a plan in place. RRSPs are meant for retirement savings and you should plan accordingly.

Before making the decision to withdraw from your RRSP, consider the other alternatives available to you. A TFSA is more flexible, and the amount withdrawn can be recontributed in the following year.

Non-registered accounts or Lines of credit are other options to consider for urgent sources of funds.

Further Reading:

4. Not investing your contribution

Another common RRSP mistake to avoid is leaving your contributions in cash and not investing it.

RRSP’s tax-sheltering and tax-deferred benefits are maximized when you invest your contributions in investments with higher returns than cash.

When you leave your contributions in cash, you are missing out on compounded returns over the life of the account. You can hold different asset types like stocks, bonds, GICs or mutual funds in your RRSP.

Just do an assessment of your investment goals, time horizon and risk appetite to decide on an appropriate asset allocation.

For example, if you plan to take money out in a few years for a house down payment, you shouldn’t be too invested in stocks. You should have a substantial allocation to “safer” investments like GICs or bonds.

On the other hand, if retirement is still decades away with no short-term plan to make any withdrawals, then a higher allocation to stocks could be more appropriate.

5. Not taking advantage of income splitting

This is a common RRSP mistake made by couples with a big gap between the income of both spouses. Contributing to a spousal RRSP is a great way to reduce taxes due at the withdrawal stage but few Canadians take advantage of its tax planning benefits.

For example, Maria, a higher income spouse, with a contribution room of $15,000 can choose to contribute $10,000 to her own RRSP and the balance to the spousal RRSP of her partner, Mark.

Maria will get the tax-refund on the entire contribution of $15,000 at her higher marginal rate. At retirement, they’ll withdraw from their individual RRSPs, with Mark at a lower rate, resulting in a lower tax paid compared to if the entire contribution were made to Maria’s RRSP.

But be aware of the 3-year Attribution Rule for spousal RRSP. If any contribution made to a spousal RRSP is withdrawn within 3 years, the money will be added to the income of the contributing partner and taxed, at that year’s marginal rate.

Using the example above, if the $5,000 contributed to Mark’s RRSP is withdrawn within 3 years, the income will be attributed to Maria, not Mark.

6. Waiting to receive the tax deduction

For many Canadians that contribute to their individual RRSP accounts, the usual practice is to wait till they file their tax to receive the tax refund due to them.

But CRA allows you to adjust your payroll deductions for contributions made to your individual RRSP accounts. Your employer should be doing this already for your group RRSP contributions, but you can also do the same for your individual RRSP.

You will need to provide a letter of authority to your employer. The letter can be gotten through any tax office close to you by sending in a written request or completing Form T1213, Request to Reduce Tax Deductions at Source.

7. Not investing your tax-refund

Your tax-refund is yours to do as you wish and there’s the temptation to spend it on frivolous things. But if you are in the habit of treating it as a windfall to be spent as you wish, you’re missing out on a great opportunity for compounded growth.

Instead of spending your refund, you can re-invest it in your TFSA or back in your RRSP. If you have children, you can also contribute it to your children’s RESP. This way, you’re allowing the original contribution to grow at a faster rate and taking advantage of tax-free compounding.

And if you don’t invest it, then use it on any other expense you would have paid anyway, for example an annual professional due, life insurance premium etc.

Related Post: Keep More Of Your Income And Reduce Your Tax Refund

8. Using RRSP instead of TFSA

Not taking advantage of the tax-sheltering opportunities of RRSPs is bad but using it when it is not the best choice could be worse. The advantage of an RRSP account is maximized when you contribute at a higher tax rate but withdraw are a lower rate.

A TFSA is probably a better alternative when your income is still low and you are in a lower tax bracket.

Also, if you think you will need the money in a few years time, and the purpose is not for a first home or post-secondary education, then you should not be contributing to your RRSP.

The tax refund you receive for your contribution isn’t enough justification. Remember that RRSP is just a tax-deferred saving plan, not tax-free. So, taxes will be due some time in the future.

Related Post: Beginner’s Guide to TFSA (How To Start Investing With TFSA)

9. Not taking advantage of your employer’s match

Many employers include RRSP matching as part of their employee benefits. Unfortunately, many Canadians don’t take advantage of this.

In most cases, the employer will match your contributions 100% up to a set percentage of your annual gross salary. For example, a 5% match on an income of $60,000 means that when you contribute $3,000, your employer will add the same amount to your Group RRSP.

This is an immediate return of 100% in your RRSP. It’s not exactly free money if your annual compensation is made up of your salary, bonus if any and the RRSP match. So why would you want to leave this money unclaimed?

10. Not planning for succession

Another less obvious mistake to avoid is poor succession planning for your RRSP: that is what happens to your investments when you die.

Not designating any beneficiary or using the wrong one will cost your loved ones dearly, both money-wise and extra stress.

At death, it is assumed that you have liquidated your entire RRSP holdings at the current market value and the proceeds added to your income for the year and taxed. For someone with a size-able portfolio, this could be quite material and costly for your estate.

Fortunately, CRA allows you to designate some of your loved ones as beneficiaries, with the RRSP transferred to them on a tax-deferred basis. They are called qualified beneficiaries and include

  • a spouse or common-law partner
  • a financially dependent child or grandchild with physical or mental infirmity of any age
  • a financially dependent child or grandchild under 18 years.

In most instances, you can make this designation with your financial institution, except for Quebec that requires the designation included in your will.

So, it’s always a good idea to review your beneficiary designations regularly, especially after every major life event.

Final thoughts

The RRSP is a great financial tool for retirement savings for many Canadians and avoiding the RRSP mistakes above will get you to your financial destination quicker.

To learn more about RRSPs, check these posts on RRSP FAQs and Common Misconceptions.

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Simon is a CPA by day and a Personal Finance Blogger by night. With over a decade experience in financial services, he's passionate about personal finance, investing and helping people take control of their financial life.

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