I have seen the rise and fall of RRSP programming. I saw investors pour money into RRSPs trying to maximize every tax deduction and save for retirement. Today investors are wondering whether it is still a good idea. Remember, it is a tax deduction today, not at retirement. Here are some of the mistakes I have seen.
RRSP Mistakes and How to Avoid Them
First, procrastination–putting it off each year and then planning to really save at a later date. The key factor as an investor is time and the compounding growth. Investing a small amount earlier may help you retire earlier.
Second, not knowing the real cost of your retirement. In retirement planning, don’t ask yourself when you want to retire but how much you need each month during your retirement. Keep that number in your head as your key retirement goal. If you have enough to meet your plans, then you are in control and can say when you will retire.
Third, not understanding what risk really means. The greatest risk to investments, about which few people are aware, is inflation. Over time, inflation erodes returns, in turn reducing your future buying power. To keep ahead, your money has to work for you and your portfolio returns need to keep ahead of inflation.
Fourth, inadequate diversification. Diversify your portfolio by asset class, geography, and style of investments. Do you have all your equity investments in Canada? Can you name three or four holdings inside your RRSP right now? Are you comfortable with these holdings? Ask yourself these three tough questions.
Fifth, buying mutual funds based on last year’s performance. Hey, anyone can pick a five-star fund; that’s why they rate funds, so everyone can pick them. Find a consistent performer and management style over the long term, say five years. Be skeptical of spectacular performance results from small funds. High single-year numbers should raise caution flags. Remember, as investors we are looking for bargains.
Sixth, staying too long with losing investments. I know it is difficult to change, but you can ask for help. Talk to an advisor who can help you change what isn’t working. One phone call may give your portfolio new life.
Seventh, missing income-splitting opportunities by not purchasing spousal RRSPs. Although the current Government rules allow for income splitting in retirement, the rules may not apply to you or may change again.
Eighth, not naming a beneficiary. Your spouse can receive your RRSP tax-free and you can also name a charity (with certain provisions) as a beneficiary.
Ninth, disorganization, having statements all over the place and missing maturities and holdings. Ask your advisor to help consolidate and get organized.
Tenth, not realizing how easy it is to transfer RRSPs from one institution to another. Most financial institutions can hold assets of any kind and transferring is relatively easy and tax-free.
Good luck avoiding making RRSP mistakes.
Here’s Relief for April 30
Does April 30 drain you? It’s the annual income tax filing deadline.If you would like to effortlessly put money back into your life before the deadline, here are some solutions for you.
Figure out if you are going to owe money this year. If the answer is yes, consider these possibilities. Look towards tax deductions. Now that the year is over, the final remaining tax deduction is your RRSP.
That’s right. We are all too busy in December and would rather think of Santa Claus than the Grinches in Ottawa. But there is still time. You have until March 1 to make a RRSP contribution. The common question is how much. A simple rule of thumb is 10% to 15% of your gross income. “Right. Grant, I can’t afford that.” Well then, do the next best thing, put in what you can afford and consider a RRSP loan. If you’re getting money back, a loan makes complete sense. Borrow the money now, get it back in April, and pay off the loan. Simple math and easy to do, unless of course you enjoy sending cheques to the Government.
The next argument is, “I heard RRSPs aren’t that great anymore.” Now I’ll stop that argument with, “If I could guarantee you 25% to 40% return on your money immediately, would you invest? Where else can you invest and do that?”
A RRSP provides you with a tax deduction for this coming April; and while the money grows, it’s tax-sheltered. When you retire, you only pay tax on what you take out; and you’re in control of that until you are 71, when you have to take out a certain amount each year.
Only in Canada, eh? Pity. Other counties don’t have a generous RRSP program, yet only 5% of Canadians maximize their RRSPs every year. Go ahead, be a skeptic, pay the Government. After all, it’s only money.
Is Your RRSP Locked In?
Another common error is misunderstanding locked-in RRSPs. Individuals with money in locked-in RRSPs usually find themselves waiting too long to use the money and finding out that they cannot take out from the plan as much as they expected. If you have money in a locked-in RRSP, there are a few strategies you can use to get the maximum amount of money out earlier. Before you transfer your locked-in RRSP to a LIF, LIRA, or LRIF, check which will pay out the most over your lifetime. Each Provincial pension plan has different rules and Federal pensions are also distinct.
As early as possible, plan to take out the annual maximum. This is 55 years of age, if the funds are from a BC pension plan. If the funds are from another province, you may take it out earlier; for example, the age in Alberta is 50. Once you transfer to a LIF or LRIF plan to take out the maximum available each year, Provincial pension legislation calculates a maximum amount that can be withdrawn. If the maximum is not withdrawn, it continues to be locked in. All withdrawals are included in income for the year and are subject to tax. However, if you are still working, you can withdraw the maximum from your locked-in RRSP and contribute those funds into a regular RRSP, therefore not attracting any tax and unlocking funds each year. This works for anyone under age 70.
Once the money is in a RRSP, you can withdraw any amount at any time. This gradually unlocks your money over time and you can do this each year.
If you have a small locked-in plan, you can transfer it to a regular RRSP and take it out any time. The definition of “small plan” changes and varies by province, but it is targeted for plans approximately $16,400 and less. Keeping up with each provincial change is challenging, but ask your sponsoring plan administrator or financial professional. Plan to unlock as much as possible as soon as possible, and knowing how can enhance your retirement income flexibility. Visit the provincial Web sites for the latest updates and tax changes.
Some men go through a forest and see no firewood. – English Proverb
It is no disgrace to start all over. It is usually an opportunity. – George Matthew Adams
Published with permission from Grant Hicks