Retirement is an essential phase of life that leaves the working days behind and onsets the stress-free phase. Retirement planning is crucial for leading life without any tumultuous turns. Investing instruments such as Registered Retirement Savings Plan (RRSP) and Tax-Free Savings Account (TFSA) are the must for it. This article will help you with the top 15 RRSP and TFSA mistakes to avoid in Canada.
RRSP is the most ideal account for depositing your retirement savings in Canada, hands down. It also serves other purposes that lead to benefits after retirement. This includes an installment for your home or education. While the TFSA account, TFSA account is more liberty-proofed and can help you in the acquisition of multiple goals in life.
No matter how the majority of people are aware of these accounts, there are still a plethora of RRSP and TFSA mistakes to avoid in Canada that people often neglect. And we have created this list to save you from that predicament.
What is a Registered Retirement Savings Plan (RRSP)?
RRSP is the name given to the account that allows people to save for their retirement and have benefits that are tax-deferred and also accumulate money for the future. There is a set limit for the contributions that you can make each year, and you get tax deductions in exchange based on your contribution.
The taxes on this account are applied only when you make a withdrawal. And once you cash out the amount from this account, you are subjected to taxes.
The money until then grows tax-free and the compound interest accelerates the pace, making it the best retirement saving tool. However, the RRSP and TFSA mistakes to avoid in Canada sum up as below.
1. Withdrawing Before the Stipulated Time
This account is meant for saving in the long run and for the future of your retirement. Hence, it is not synonymous with a fund that you can cash out whenever you feel like there is a need. You can be facing a withholding tax of over 10%-30% if you withdraw money early from the RRSP which will be deducted by the bank and transferred to the government.
This amount will also be included in your income and taxed at the marginal tax rate, insinuating that you might still have some amount due for taxes as you file your annual tax returns.
Moreover, you will not be able to accrue the total benefits of an RRSP. And this is a major drawback, the contribution room that you lost by withdrawing early cannot be reclaimed.
You can dodge these penalties if you withdraw from the Lifelong learning plan, Home Buyers’ Plan, etc.
2. Contributing More Than the Stipulated Amount
This is one of the major RRSP and TFSA mistakes to avoid in Canada. People often tend to contribute without being aware of how much they are actually allowed to. This can be found by the numbers that the government publishes each year. For instance, you were allowed to contribute up to 18% of your income in 2021, while $27,830 in 2020. You can also carry forward amounts to the next year if there is some contribution space left in your account.
A buffer of $2,000 is allowed for people who tend to exceed their contributions. Once you go beyond this amount, you will be subjected to 1% of excess contributions that you make. Hence, you should be aware of how much contribution you need to make, and how much room you have to stretch in through the Notice of Assessment sent by the CRA and hence you will monitor your contributions.
3. Blowing Through the Tax Refunds
A tax refund is always welcomed by everyone. It is often treated as a benefit by people. However, there are hidden costs that you are likely clueless about.
This tax refund makes it look like you are getting extra money, but in reality, your refund or tax deductions are the RRSP contribution that you repay in the future while withdrawing your funds.
Hence, you have to re-contribute these refunds to your TFSA and RRSP accounts. To reduce your taxes deducted at source, you should move from TD1 to T1213 for which you will not have to wait for the tax season, namely April.
4. Neglecting Your Spouse’s RRSPs
This is not majorly one of the RRSP and TFSA mistakes to avoid in Canada, but it is more of ignorance of what is in front of you. Your spouse’s RRSP helps to divide the earnings and also share the burden of supporting the family. For instance, a greater income than your spouse means you can also contribute to their RRSP under their name. You can utilize your contribution room and get tax deductions at the high marginal tax rate that accompanies your income.
Now, when you and your spouse retire, they will be cashing out more money at a lower rate, while you will be cashing out less money at a higher rate. Hence, acquiring the best of both worlds!
This helps share income with RRSP accounts and also reduces the burden of taxes for the family. Spousal RRSP is also applicable for people of 71 with a spouse being younger than that. This is possible because 71-year olds cannot put in money to an RRSP, however, with a younger spouse, they can continue contributing until they have the contribution room to spare.
5. Not Fulfilling the Matching Contribution with Your Employer’s RRSP
Free things, especially money, are more than welcome for people of every age, city, or country, and guess what? You have it in the form of employer RRSP matching contributions!
However, the more than clueless employees forget to take the benefits of this where the employers are straight away ready to match their contributions for a certain limit, and hence lose out on significant benefits. And this is prominent and tops the list of RRSP and TFSA mistakes to avoid in Canada.
Hence, you should fully utilize the right to match contributions on 3-5% of your income and hence save more for your retirement.
What is a Tax-Free Savings Account (TFSA)?
TFSA or a Tax-free savings account, as it implies from the name, allows people to grow their retirement savings tax-free. On the contrary to RSSP, this account stays tax-free even when people cash out their money, and is the best for people looking to save while lowering the taxes they pay.
This account is best for retirement savings, or reaching other financial goals, like creating an emergency fund or fulfilling down payments. This account was launched in 2009, and if you have been eligible for the same since then, you can contribute up to $75,000 ( if you have not made withdrawals or contributions yet.) Hence, in today’s article for the RRSP and TFSA mistakes to avoid in Canada, this covers the TFSA part.
6. Simply Treat It as a Savings Account
TFSA is much more than a savings account, and many people confuse it with that and limit the benefits that they can leverage from it. Hence, the deposit money put GICs in TFSA and withdraw as per their will, without thinking of other goals.
However, it should be treated more like an investment account and ensured that you are maximizing 100% potential of getting from it. It may be more flexible than the RRSP, but carries just as much importance in regards to retirement.
It is sensible to use it as a savings account or emergency funds, but even more sensible to build long-term savings and fulfill financial goals for the future.
7. Not Taking Much Risk
You can become too conservative of an investor if you just create a TFSA full of GICs or savings. Hence, limiting your benefits as we mentioned before. If you are having a short-term financial goal like a wedding, vacation, down payment, etc. then it is fine.
However, retirement savings for 10-20 years in advance needs a more bold approach and risk embracing approach. That is because you can make many financial instruments tax-free in a TFSA including gold and silver bars, bonds, mutual funds, stocks, GICs, etc.
8. Contributing More Than Needed
The Canada Revenue Agency (CRA) is levied with the duty to publish the maximum contribution limit for the TFSA every year. You are allowed to contribute up to that limit and the left-out room that you brought from other years. For example, in 2021, the contribution limit was $6,000.
You are not allowed any buffer amount here like the RRSP, and you will be penalized 1% of your excess contribution monthly. Hence, if you made a $1,000 excess contribution to your TFSA, and you refrain from withdrawing that money before the year ends, then you are obliged to pay $120 as taxes/penalty.
Over-contribution is one of the common RRSP and TFSA mistakes to avoid in Canada because people often forget to track their contributions, or they also re-contribute the amount they withdraw for the same year.
9. Transferring the TFSA to a Different Organization
Cashing out the TFSA savings and transferring to a different TFSA is also a contribution to TFSA, and it will also be treated as an over-contribution with tax penalties that follow. Hence, if you want to transfer your TFSA, do it via the filling of Form T2033. You can also consult your bank and let them help you avert any looming tax penalties or fines.
10. Putting in the U.S. Stocks in TFSA
If you put foreign dividend tax in your TFSA of the U.S., these amounts will be imposed with the withholding tax. For instance, U.S. stocks carry a withholding tax of 15% and you cannot recover them. However, you do not pay this tax when the same asset is in the RRSP account.
Hence, holding U.S. stocks in RRSP or non-registered accounts is a much better move. However, taxes are always present in some way or another when you are using the investment accounts.
Common RRSP and TFSA Mistakes to Avoid in Canada
People also tend to make combined mistakes for RRSP and TFSA, and we will tackle them in this article too. Here are some of the most common ones are below.
11. Not Diversifying Adequately
TFSA/RRSP should be diversified sensibly so it can withstand the rather tricky movement of the market. You can accomplish this goal without any problem by investing in ETFs or index funds. If you are a self investor and handle your investments on your own, you should go for a multiple-fund portfolio. You should also re-balance it promptly. While buying stocks solely, ensure to buy from different ones to diversify.
12. Drawing in Fees
Investment fees cost a big chunk of your returns. In Canada, you will encounter a high fee for active equity mutual funds which stands at an average of 1.98% each year. However, the mutual fund managers for it usually do not meet their benchmark, hence your high fee isn’t bringing the results you desire.
Hence, you should pay great attention to what fee you are paying, and the returns that you are getting. On the other hand, ETFs are a less costly choice. You can also get a one-fund ETF which is usually free of re-balancing needs. Robo-advisors are also a good alternative that charges a low fee and also comes with added benefits.
13. Investing in Non-qualified Investments
You cannot put every kind of investment in the TFSA and RRSP accounts. The ones that can be held in it are called the qualified investment while the ones that fall out of that category are called prohibited or non-qualified investments.
If you put the latter in the account, you will be subjected to a heavy tax of over 50% on the market value of that asset in question, and 100% tax is imposed on the return that you get.
14. Investing Through Waiting
RRSP and TFSA mistakes to avoid in Canada involve waiting for the right time to invest instead of taking action right now. Hence, you should take the required action right away, without pondering about the outcome for too long.
15. Slacking Financial Plan
You should always plan your financial goals in advance for the RRSP and TFSA accounts. The update should be done as per the progress and changes in your goals, and risk tolerance. You can also minimize your tax by putting it in the RRSP account instead of a TFSA.