If you’re planning for retirement, it pays to open an RRSP.
Already achieved that milestone? Then give yourself a pat on the back. In 2016, only 5.9 million Canadians contributed to an RRSP plan, so if you’re already working on yours, you’re way ahead of the game.
However, merely contributing to an RRSP isn’t enough. In order to get the most out of your RRSP, you need to a solid strategy for maximizing the balance when you retire–and ensuring you won’t be hit with surprise taxes when you withdraw.
Most Canadians are already aware of the tax implications of withdrawing from an RRSP early, or while still earning a salary. However, there are some subtler RRSP mistakes to avoid as well. The following are three of the most dangerous.
Mistake #1: not contributing enough
According to Statscan, the average Canadian contributed just $3000 to their RRSP in 2016. That’s only a tiny fraction of what the average salaried worker can contribute. Legally, you’re entitled to contribute 18% of your income up to a max of $26,500 (2019).
If you have $26,500 worth of extra money in a given year and you’re only putting $3000 into your RRSP, you’re missing out a veritable mountain of tax-deferred gains.
Mistake #2: contributing too much
Most people probably know that they should contribute as much as they can to their RRSP. What most don’t know is that they should avoid contributing too much. If you over-contribute to your RRSP, the excess amount is not tax-deferred.
While there’re no RRSP over-contribution tax like there is with TFSAs, having a portion of your RRSP that’s not eligible for tax deferment can be a pain come tax season.
If you have an employer pension or RRSP matching program that could push your contributions over the limit, definitely speak with an accountant to see how much you can really contribute.
Mistake #3: not diversifying your holdings
A final RRSP mistake is not diversifying your holdings once they’re in the account. For most amateur investors, diversification is a great way to protect against the risks present in any one holding. However, too many investors make the mistake of putting all their RRSP eggs in one basket.
We can illustrate the dangers of not diversifying by reference to a very well-regarded stock: Canadian National Railway (TSX:CNR)(NYSE:CNI).
CNR appears to have everything going for it. It has a safe business protected by high barriers to entry. It enjoys loads of cross-border freight business with the fast-growing U.S. economy.
It pays dividends and increases the payout almost every year. It’s buying back its own shares to increase shareholder equity. In summary, it’s about as safe an individual stock as you’ll ever find.
Yet even in this generally safe stock, we can see some risk factors. Continued appreciation of the Canadian dollar would eat into its earnings. A slowdown in the U.S. economy would hurt those lucrative cross-border runs.
A sudden breakthrough in Canada’s long-delayed pipeline projects could hurt the crude-by-rail business. So even CNR–a great stock by any standard–could end up being a dud, and you can bet that what’s true of CNR is true of any other stock.
For this reason, unless you have expertise, it’s always best to diversify your RRSP.
