Did you know that Registered Retirement Savings Plan (RRSP) withdrawals are fully taxable by the Canada Revenue Agency (CRA)?
It’s something that Canadians are told when they open their RRSPs, but not something that many of them seriously contemplate. One of the benefits of RRSPs is that they defer taxation to the future — ideally, until you retire. This makes the taxation on withdrawal fair — assuming that you are retired in the traditional sense of the word (i.e., not working at all).
The problem is that these days, not very many people are “traditionally” retired at all. Due to inflation, many retirees are finding themselves having to work part-time jobs even after formally “retiring” from their main careers. It’s not exactly a recipe for easy living. More pertinent to this article’s topic, it can also result in your RRSP withdrawals being taxed at much higher rates than you’d expect. In this article, I will explore three CRA red flags for RRSP withdrawals in retirement.
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Red flag #1: Withdrawing while still working
A major red flag for RRSP withdrawals is making them while you’re not working. This particular red flag is not one that the CRA will care about or scrutinize you for, but it will result in you paying more taxes to the agency.
The problem with making RRSP withdrawals while still working is that it results in you paying higher taxes than you’d pay if you withdrew while not working. The higher your tax rate, the higher your RRSP withdrawal taxes. So, don’t make RRSP withdrawals while still working if you can avoid it. You’ll thank me later.
Red flag #2: Overcontribution
Another major CRA red flag pertaining to RRSP withdrawals is overcontribution. Overcontribution is when you contribute more to an RRSP than you are allowed to. Currently, the maximum a Canadian can contribute to their RRSP is $32,490 or 18% of their income, whichever is lower. If you contribute more than that, expect to pay a 1% monthly tax on the amount in excess of your limit.
Red flag #3: Unauthorized investments
A final CRA red flag for RRSP withdrawals is unauthorized investments.
An unauthorized investment is any investment that the Federal Government doesn’t allow you to hold in your RRSP. These include foreign private companies (not foreign stocks); direct real estate holdings; and some especially risky derivatives. If you hold these in your RRSP, you may face negative consequences.
Fortunately, the CRA red flag about unauthorized RRSP investments is easy to avoid. Simply hold Canadian-listed stocks and exchange-traded funds (ETFs) in your RRSP, and you will be golden.
Take iShares S&P/TSX Capped Composite Index Fund (TSX: XIC) for example. It’s a Canadian index fund built on the TSX Composite, the 240 largest publicly traded companies in Canada. The fund is very diverse, holding tech stocks, bank stocks, energy stocks, and more. It holds 220 of the underlying index’s 240 stocks, making it quite representative of the index it tracks. Finally, the fund is not very pricey, as it has a 0.05% management fee, a 0.06% management expense ratio (MER), and a 0.01% bid-ask spread. These metrics argue that XIC is not the sort of ETF that will cost you a mountain in fees. So, it may be an ETF worth holding.
