10 RRSP DOs and DON’Ts

The goal of RRSP investing is a comfortable retirement. While you’re ultimately responsible for the performance of your RRSP, we’ve put together a guide that will help you avoid some pitfalls along the way.

10. DON’T – Forget to diversify

Large pension funds spread out investments among stocks, bonds, income trusts, cash (short-term investments), commodities and hedge funds.

9. DON’T forget about spousal RRSPs

DON’T – Ignore the income-splitting benefits of contributing to a spousal RRSP: Couples, whether they’re legally married, living common law or involved in a same-sex relationship can save tax here – particularly if one spouse expects to have a lower income during child-rearing years or in retirement.

The federal government’s new pension-splitting rules mainly apply starting age 65. Plus, a great many Canadians don’t have access to the defined-benefit pension plans that create this type of pension income in the first place.

If you are smart in your RRSP investing, you probably will be in a position to retire earlier than 65 and having money in a spousal plan will allow many couples to balance their taxes accordingly.

8. DO – Find the right advisor

DO – Find an investment advisor you can trust: And then get everything in writing. A well-crafted policy statement — a standard with pension accounts that frequently have to answer to others — can serve as both a blueprint and a report card for your relationship.

A good policy will spell out the reasons you bought the investments in the first place and what might prompt you to change your mind. It will also detail what you anticipate making over different time periods, as well as the range between the best likely result and the worst. This, in turn, makes it possible for you and your advisor to determine how you’re doing and whether your blend of assets is still in line with your lifestyle.

7. DON’T – Borrow for longer than a year

DON’T – Borrow to contribute unless you can pay back the money fairly quickly: Interest on such borrowings is not tax-deductible.

If you do borrow the money to make a contribution, try to pay off the balance through the year. You can, for instance, pay back a large portion of the loan as soon as your refund arrives. Unless you already have debt problems, this is a good way to keep up with a sound contribution schedule.

If you do have debt concerns, don’t lose sight of the bigger picture in order to save a bit of tax. In some instances, you may be better off living on a budget and setting up a ‘pay yourself’ regular monthly contribution plan.

6. DO – Go international

DO – Consider increasing your international exposure: Canada only represents about three per cent of the world’s investment opportunities and many of the biggest, most profitable companies are outside our borders. While Canada is certainly on a roll right now, going overseas helps reduce risk in your portfolio by diversifying away from our resource-heavy economy. What’s more, the top performing countries vary from year to year. Over the past 10 years, Canada has only been the top performer a couple of times. Studies have consistently shown that investing in a mix of Canadian and international stocks produces better potential returns over the long term, with less risk, than investing in Canada alone. And with the Canadian dollar running pretty hot, there may be money to be made should the loonie retreat at some point.

5. DON’T – Pay fees unnecessarily

DON’T – Pay fees unnecessarily: This means you have to find out about the fees you are paying and judge if they are worth it. Many investment advisors count on you not thinking about it. A good example is a bond fund holding government bonds and charging a management expense ratio (MER) of around 2 per cent a year thus chewing up half or more of the expected return. Paying that much for an equity fund may be worth it, but it would be better to hold bonds directly or at least choose a low-fee bond fund, such as an exchange traded fund (ETF) for which the MER is less than 0.5 per cent per year.

4. DO – Go long

DO – Achieve the highest possible longer-run return: The person contributing $5,000 a year from age 25 would have an extra $296,567 in his or her RRSP at age 65 if the average annual return in the portfolio is 8 per cent instead of 7 per cent. Check out the numbers on one of the free RRSP calculators located at a bank, mutual fund website or here.

3. DON’T – Withdraw money

DON’T – Take funds out of your RRSP: Not only will the withdrawal be fully taxed as income, you will miss out on tax-free compounding.

Plus, all financial institutions are required by the Canada Revenue Agency to charge applicable withholding taxes on lump sum retirement withdrawals. This is not your total tax liability though; it is just a down payment on what you owe. You will be hit with a 10 per cent charge on the first $5,000, 20 per cent on amounts between $5,000 and $15,000 and 30% on amounts over $15,000.

In the meantime, you will also be giving up valuable RRSP contribution room.

2. DO – Contribute early

DO – Take advantage of the power of tax-free compounding: Contribute as much as possible early in life, even if it means postponing the purchase of a house. A common regret among those now approaching retirement is that they didn’t put enough money into an RRSP early on. A person starting annual contributions of $5,000 at age 25 would have $998,176 at age 65, but only $204,977 if the contributions started half-way there at age 45 (assuming a compound return of 7 per cent annually).

1. DON’T – Delay

DON’T – Procrastinate: It is easy to find reasons for not investing in an RRSP: buying a home, raising a family, or just simply never getting around to the task. But there is no getting around it, as you grow older, it just becomes that much harder to make up for the lost years when you didn’t invest.

That double-whammy — less time to save, more time for your money to last — is what makes turning the dream of a successful retirement into reality such a challenge.

Things are not going to happen by themselves. You need to make a plan, take action and be decisive. It’s your life in retirement.

Published in: on February 19, 2011 at 6:41 pm  Comments (5)  

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5 CommentsLeave a comment

  1. 10 Rrsp Dos And Donts Black Belt Review…

  2. Great article. I was checking continuously this blog and I’m quite impressed! Very useful info specially the first part. I care for such info a lot. I was looking for this particular information for a long time. Thank you and best of luck.

  3. Amazing piece. I was checking continuously this blog and I am quite impressed! Very helpful information specially the last part. I care for such info much. I was looking for this particular info for a very long time. Thank you and good luck.

  4. Great post. I was checking constantly this blog and I’m impressed! Extremely helpful information specifically the last part. I care for such info a lot. I was seeking this certain information for a long time. Thank you and best of luck.

  5. 10 great things everyone should check annually.

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