It's RRSP season, and you're going to get a lot of advice about how to maximize your contributions, borrowing to contribute, the benefits of contributing, and how to invest inside your registered retirement savings plan. It's all good stuff when the advice comes from the right sources. But I want to talk about the six most common mistakes that people make with their RRSPs. If you avoid these blunders, you'll save tax, create greater retirement savings for yourself, and protect those assets.
Wrong asset location Many times I see people holding interest-bearing investments outside their RRSPs and equities inside their registered plans. To the extent you're going to have cash, near-cash or fixed-income investments in your life, you should first hold them in your RRSP (or RRIF) to the extent possible. If you still have room in your RRSP for other investments after placing your highly-taxed interest-bearing investments in the plan, then go ahead and hold your equities in your registered plan as well.
Making withdrawals to pay short-term debt It just doesn't make sense in most cases to make taxable withdrawals from your RRSP to pay down debt, particularly short-term debt. The problem is that you're likely to pay more in tax on that withdrawal than you'll save in interest costs by paying down the debt, particularly if the debt is short term.
In addition, you will have wasted valuable RRSP contribution room since you don't get that room back again when you make a withdrawal. If you wanted to replace those dollars by putting more back into your RRSP later, you'll have to use up new contribution room to make that possible. Finally, making a withdrawal to pay down debt often happens at a time when markets have declined, and you'll be turning a loss on paper into an actual loss.
Contributing losers in kind If you have investments outside your RRSP and you're thinking of contributing those investments to your RRSP, be careful not to transfer in the ones that have declined in value. You'll be deemed to have sold those investments at fair market value when transferring them to your RRSP, and any capital loss that arises will be denied under the superficial loss rules in our income tax act.
Instead, sell those investments on the open market, then contribute the cash to your RRSP so you can claim the capital loss. If you hope to acquire the same securities inside your RRSP, you'll have to wait 31 days after that contribution to your RRSP to make the investment, otherwise your capital loss on the sale outside your RRSP will be denied under the superficial loss rules.
Claiming your deduction in the wrong year When you make a contribution to your RRSP, you're entitled to a tax deduction for the amount contributed within your contribution limit - but you don't have to claim that tax deduction in the year you make the RRSP contribution.
You can claim that deduction in any future year if you choose. If you expect your income to be higher in the next year or two such that you're in a higher tax bracket, consider deferring your RRSP deduction until that future year. You'll save more tax this way, which could make this idea worthwhile even though you're postponing the tax savings for a year or two.
Forgetting to monitor your beneficiary designation You should understand that when you separate or divorce, the beneficiaries you've named on your RRSP or RRIF account forms are not revoked. I've seen more than one case where a former spouse became entitled to RRSP or RRIF assets because the account owner forgot to make a change to the named beneficiary after the separation or divorce. It's a good idea to review who your beneficiaries are on a periodic basis, even if you're not separating or divorcing.
Combining spousal and non-spousal assets If you have both a spousal RRSP and a non-spousal RRSP, be aware that if you combine those accounts at some point, all of the money in the combined account becomes "spousal" RRSP dollars.
These dollars are then subject to the rules that could cause some withdrawals to be taxed in your spouse's hands instead of your hands to the extent your spouse has made contributions to a spousal RRSP in the year of the withdrawal or the prior two years.
Tim Cestnick