3 RRSP pitfalls

Before you contribute, educate yourself.


(Photo: William Andrew/Getty Images)

RRSP season has arrived. For the next three months, Canadians will be inundated with articles, broadcasts and ads offering advice on how to manage their registered retirement savings plans.  There may be something to learn from it all, but pitfalls also lurk. Here are three everyone should consider.


1. The merits of saving for retirement

RRSP owners will get an earful on the importance of saving for retirement. The magic of compounding returns will be referenced. So will the merits of starting at an early age, as will the need to amass a retirement fund large enough to replace a high percentage of your current income.

Yet paying down debt can be a better way to prepare for retirement, particularly given the present choice between miniscule yields on fixed-income investments and uncertain returns on stocks. If a mortgage charges 4% interest, paying down a chunk of the principal provides a certain 5% to 7% return for most people depending on their tax bracket (the reduction in interest payments frees up this amount of pre-tax income as a percentage of the principal amortized).

With Canadian debt-to-income ratios so high nowadays, there is a lot to be said for paying down financial obligations. Saving for retirement is laudable, but I suspect the benefits are over-promoted due to the incentives for advisers who earn commissions and fees on purchases of financial assets.

2. Where to invest RRSP contributions

During the RRSP season, the media offers suggestions on where to invest RRSP contributions.  But such advice is for a mass audience and the recommended stocks or funds that catch your fancy might not be appropriate for your portfolio.

If you have 75% in stocks and 25% in bonds, for example, you may not want to bring in another stock or equity fund—especially if your target weight was set at 75% or lower for stocks. Going above that exposure could be cause for regret during the next meltdown. Mr. Market won’t accept any excuses about not keeping track of asset allocations or letting a bullish mood lull you into greater risk-taking.

A prospective investment may also give your portfolio too much exposure to a particular region or industry. For example, shares in CP Railway Ltd. might have great fundamentals, but if your portfolio is already loaded with cyclical stocks the result could be a great deal more volatility than you feel comfortable with.

As Modern Portfolio Theory advises, think about how potential investments fit into your portfolio. If your holdings end up moving together, the wide gyrations in performance could lead to some anxious moments, perhaps even panic selling at market troughs. It’s good to have some positions zig when others zag—unless you are a highly risk-tolerant investor.

3.  The benefits of tax savings

Discussions of the tax benefits of RRSPs typically gloss over who they really favour. In fact, they are mainly advantageous to Canadians in the highest tax brackets. This group has a chance of being in a lower tax bracket during their retirement years so that they end up paying less tax over their lifetime (although they could discover otherwise if governments resort to tax hikes to address the country’s financial difficulties). RRSP holders in low tax brackets are much less likely to retire to lower tax brackets and to see a reduction in lifetime tax burdens. Indeed, many find they end up in higher tax brackets. For these Canadians, a Tax Free Saving Account (TFSA) is the better option.

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9 comments on “3 RRSP pitfalls

  1. Ah where 2 invest?
    real estate
    dabt paydown
    direct into oil companies
    farm land
    off shore out of country?
    All within a verifyable RRSP account of course,
    but all you folks talk about is stocks stocks stocks, and some bonds
    maybe a stock through an ETF or horrors, a USA stock
    Stocks stocks stocks
    Is there no imagination out in writers / experts lands?????

    • Just interested…. what would you invest in?

    • Hi 17walter. A lot of those “alternative” investments you mention (such as real estate) come with a lot of complications and high fees that make them only suitable in special situations, if that. You know, it’s the kind of stuff many financial “advisors” like to sell, er, recommend.

  2. TFSAs only pay 1-2% interest. Not paying tax on this interest is insignificant. Putting the same $5000.00 into an RRSP gives you the same tax free interest, as well as a tax refund of up to $1500.00 depending on your tax bracket, which can then be put into debt repayment or into next year’s RRSP. Win Win with the RRSP. It also makes it easy to save money for those who tend to spend everything they have.

    • Hi Duffliss. For TFSA with savings accounts, one can earn 2.5% to 3% – see http://www.canadianbusiness.com/investing/year-end-must-do-transfer-to-a-better-paying-tfsa. One can also hold stocks and bonds in a TFSA to shoot for higher returns. If they bomb, one still has the contribution room. Not so in an RRSP. Your suggestion to contribute to RRSPs and deposit the refund is the age-old strategy recommended by many financial advisors. But it could lead to investors paying more tax over their lifetime when at 71 they roll the RRSP into a RRIF and discover the mandatory withdrawals at high rates put them in higher tax brackets and claw back old-age benefits.

  3. The CIBC authored an article aimed at the Business Owner suggesting that RRSP’s may not be the best alternative . . . many business owners need not only the retirement income in the future but need peace of mind and security – arguably more – protection of whatever assets they have built up is critical and while it may not appear to be sexy – Life Insurance companies have plans that offer protection that cannot be found elsewhere.

    Most banks have their own life insurance entities – so if traditional life insurers scare you then use your bank – Bank of Montreal Life is truly trying hard to win Canadians over – some of their traditional Life Insurance ‘Par’ products circa 1960’s are considered to be very good alternatives for Business Owners today. They offer very good ROI from the dividends and provide excellent benefits being “Creditor Protected” and to fund these the money should stay in the corporation – in other words – the corporation should be the owner of the plans – as there is a significant tax deferral on these funds into retirement – and they will not create clawback of other pension income in the retirement years as RRSP or RRIF income does in the retirement years.

    Therefore it follows – if you are a business owner – you need to get a second opinion before contributing to your RRSP portfolio – it is all about tax deferral – and maximizing income into the retirement years and Insurers have provided solid guaranteed incomes – ask your insurance broker or Financial Planner about plans with resetting privileges as well – as these plans can provice additional peace of mind that your money invested will never go below the ‘resetted amount’ which compared to mutual funds or other investments is true peace of mind – the last thing you want to do in retirement is worry if you are running out of money and how well your investments are doing.

    Finally ask your Accountant about receiving Dividend Income from your own Corporation – if they are a Tax Specialist they should be able to set you up to receive $ 66K of income annually personally and pay no tax on these funds – and if you have a family member or spouse to split income with they too can receive $ 66K of income from your own corporation with no tax – that’s $10K coming into the family – most Canadians should be able to live on this – then the question is – why do you need a RRSP in the first place then?

    It’s all about HOW YOU REMUNERATE YOURSELF – not how do I remedy the tax situation I got myself in by putting me and my spouse on payroll from my own CCPC.

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