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Retirement and RRSPs

Six things people often don’t understand about RRSPs Add to ...

Decades before LOL and FYI and IMHO, there was RRSP – a four-letter acronym that’s become an everyday term in the country’s lexicon. But while most Canadians today know about RRSPs, there are still plenty of misconceptions and questions about them, say financial planning and investment experts.

“There are technical issues that people don’t always understand,” says Howard Kabot, vice-president of financial planning, at RBC Wealth Management Services in Toronto. “There are rules that need to be followed, and sometimes there’s confusion about the rules.”

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Having a good grasp of these rules and technicalities can help investors ensure they get all the benefits of an RRSP and avoid unnecessary penalties, the experts say.

1. Contributions are based on which year’s income?

RRSP contribution room for each tax year is based on earned income from the previous year. Plain and simple, right? Not to everyone, Mr. Kabot says. Some Canadians get mixed up because RRSP contributions for a given tax year can be made until the end of February or beginning of March the following year.

“Where it gets confusing is, in the first 60 days of 2014 you’re allowed to make RRSP contributions for the 2013 tax year and your 2013 contribution is based on your income in 2012,” Mr. Kabot explains. “So if you had a pretty good income in 2012, but earned less in 2013, you may think that you don’t have as much contribution room, which isn’t the case.”

2. Nope, you can’t double up with a spousal RRSP

A spousal or common-law partner RRSP is a good way to split investment income or capital gain from registered retirement savings between a couple and reduce their overall tax bills later in life. What it doesn’t do, however, is double RRSP contribution room and allowable tax deductions, Mr. Kabot says.

If, for example, you’re allowed to contribute $10,000 for the 2013 tax year and your spouse is allowed to contribute $2,000, the most you can put into both of your RRSPs is $12,000. Also, the person who made the contributions is the only one who can claim a tax deduction.

3. Yup, you can hang on to those tax deductions

Most Canadians know they can carry forward unused RRSP contribution room. What’s less known, Mr. Kabot says, is that tax deductions on RRSP contributions can also be applied to future tax returns, in particular against high-income years. But this means resisting the temptation to claim an RRSP contribution – which likely means getting a cheque from Canada Revenue Agency – during low-income years, Mr. Kabot says.

4. It’s a holding account, not investment product

This may seem like semantics, but it’s one that has practical and financial implications, says Michael Wiener, the Ottawa-based blogger behind Michael James on Money, which focuses on saving, spending and investing. Mr. Wiener says understanding that an RRSP holds investments but is not by itself an investment can help Canadians take better control of their retirement funds.

“People think they go to their bank or financial adviser and ‘buy an RRSP’ and that will be that – they don’t have to worry about it any more,” Mr. Wiener says. “Once you understand that the RRSP itself is not an investment, then hopefully you’ll take the time to figure out what sort of investments you should be making and putting into your RRSP.”

5. It isn’t all yours: The taxman wants some, too

Mr. Wiener says some people plan their retirement based on the entire predicted value of their RRSP and are unpleasantly surprised by their tax bill when they convert their registered savings into a registered retirement income fund (RRIF) and withdraw from the RRIF. “They feel they’ve been scrimping and saving all this time and now the government is taking it away,” Mr. Wiener says. “What they’re forgetting is all those tax breaks they got over the years every time they made a contribution.”

This oversight may cause some people to retire sooner than they should or dream up a retirement lifestyle that exceeds what they can afford on their after-tax retirement income, Mr. Wiener says. His advice: Crunch the numbers, and be sure to factor in the government’s share.

6. Turning 71? You can still contribute to your RRSP

The rules say you have to convert your RRSP to a RRIF by Dec. 31 of the year you turn 71. But what if you’re still working at 71 and creating RRSP contribution room for yourself?

One option, Mr. Kabot says, is to put additional money into your RRSP before it’s closed and turned into a RRIF. CRA may apply a 1-per-cent over-contribution penalty but this should be offset by the deduction you’re allowed to make the following year. For those with a younger spouse or partner, another option would be to put that money into a spousal or common-law partner RRSP, providing there’s contribution room.

It’s not that complicated – really

Even with all the rules, RRSPs aren’t as complicated as some people think, says Peter Aceto, chief executive officer of ING Direct Canada. He suggests visiting CRA’s website to learn how RRSPs work.

“They don’t give you advice about what you should put in your basket, but they actually have some good content which explains RRSPs,” Mr. Aceto says.

Your bank, financial adviser or accountant are also good sources of RRSP information. Don’t be afraid to ask questions, even ones you think are stupid, Mr. Aceto says. “And above all, don’t let something that seems complicated stop you from doing something, because that’s the worst thing you can do,” he says. “Start saving, even if you’ve still got some questions.”

Editor's note: This version of the story has been clarified to emphasize that you are taxed when you withdraw money from your RRIF.

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