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Avoiding the seven deadly RRSP sins

A Registered Retirement Savings Plan (RRSP) should be the cornerstone of your retirement nest egg, especially if you don't have a company pension. Unfortunately, many Canadians fail to grasp the importance of RRSPs and make mistakes when managing them. Here are seven RRSP sins and tips on avoiding them.

1. We're bad at contributing
The biggest mistake Canadians make is failing to contribute to their RRSPs, says Bruce Armstrong, vice-president of financial planning at Scotiabank in Toronto.

The government pension scheme is "not going to see you through to retirement. The majority of people need additional savings and an RRSP is the best way of doing that," he says.

When getting started, it's not a matter of how much you put aside, but "doing it on a regular basis" that's important, says Armstrong. To get in the habit of contributing, use automatic withdrawals to direct 10 percent of your take-home pay directly into your RRSP. It forces you to live on less.

If you can't afford 10 percent, look for ways to cut back on spending and dedicate that money to your plan. Opt for a piece of fruit for breakfast instead of store-bought muffins and watch your RRSP grow instead of your waistline. Spend five dollars a day less during the work week and you'll have $1,000 a year to invest.

2. We wait too long
Armstrong says Canadians don't start saving early enough in life. The beauty of RRSPs is the money inside them grows tax free. The longer money is invested, the more it grows. Consider the following example, using Bankrate Canada's Savings Calculator.

A 25-year old who socks away $5,000 a year in an RRSP earning a 6 percent return would have $773,810 at age 65. Only $200,000 of that would be actual contributions. The rest reflects investment earnings from those contributions.

Compare that to an investor who starts saving $10,000 a year at age 45 and earns 6 percent. By age 65, that person also would have contributed $200,000, but their total package would be worth only $367,856. The investor who starts earlier has 20 extra years to grow an investment, and accumulates more than double the retirement fund of the tardy saver.

3. We fail to maximize benefits
Joseph O'Donnell, a portfolio manager and financial adviser with RBC Dominion Securities in Fredericton, New Brunswick, says Canadians are woeful when taking advantage of RRSPs. The government allows you to put away a maximum of 18 percent of last year's earned income or $15,500 for 2004. If you don't contribute the maximum, the unused RRSP room carries forward into the following tax years.

However, a study by CIBC found the average annual contribution was only $4,400 and more than 80 percent of taxfilers had unused RRSP room. There's now $367 billion in untouched RRSP room for more than 19 million taxfilers.

Also, by contributing at the end of the tax year -- which most people do -- O'Donnell says they "are missing out on a whole year of investment opportunity," which can add thousands of dollars to your retirement fund.

To ensure you take full advantage of your RRSP, figure out the maximum you can contribute and divide by 12 (if you get paid monthly), 26 (if pay is biweekly) or 52 (if weekly). Then, contribute that amount to your RRSP in regular payments.

For example, to make the maximum contribution in 2004 (you need to earn about $86,000), you would save $1,292 monthly, $596 biweekly or $298 weekly.

Another option is to take a cheap RRSP loan at the beginning of the year and use it to fund that year's contribution. Make sure you pay off the loan by the end of the year. Rates are low, and while you can't deduct the interest, if your money grows at 6 or 8 percent, it could actually earn more than what you pay in interest on the loan.

4. We don't invest enough time to understanding RRSPs
Kevin Cork, branch manager at TWC Financial in Calgary, says many Canadians just don't understand RRSPs. They think of them as a tax exemption tool first and an investment second. Moreover, "people stick money into an RRSP and don't think about where it is actually going."

"They're not spending the extra little bit of time to learn about some options and make decent investment decisions. We spend as much time on our RRSPs as we do buying shoes," says Cork.

It means reading books and investment literature, subscribing to financial magazines and perusing Web sites such as this one. For more stories on how to get the most out of your RRSP, click here. Look at your investment statements, map out questions for your financial adviser, if you have one, or take a course through a university or college or a seminar at your financial institution.

5. We don't do any retirement planning
Armstrong says another mistake investors make is not assessing how much money they will require in retirement and what they need to save. It differs for each person and "depends on what sort of retirement you want."

O'Donnell adds that people tend to overestimate the return they will receive. "Make sure your goals are realistic."

That means planning. Armstrong says "go online. There are lots of calculators that will give you a rough idea on how much you need to have." You don't need to go far to determine how much money you'll need for retirement. Try Bankrate's Retirement calculator.

6. We stick close to home
Canada's stock markets account for only two percent of the global markets. To get exposure to other markets, investors can have as much as 30 percent of their money in foreign investments. If you buy products such as clone funds -- mutual funds that mimic foreign funds -- you can take your foreign content up to 100 percent. But, says Armstrong, "most Canadians don't take advantage of that."

In fact, studies show that performance hinges on asset allocation and holding different asset classes, such as large-cap and small-cap stocks and fixed-income products. Often, investors have too many mutual funds with the same stocks and they aren't properly diversified. To learn more about asset allocation, see William Bernstein's books, The Intelligent Asset Allocator and The Four Pillars of Investing.

7. Inefficient investing
O'Donnell says investors take on too much risk in their RRSPs and hold the wrong investments inside them. Losses from investments held inside RRSPs can't be claimed as a write-off on your tax form, so risky stocks should be held outside your RRSP.

The same goes for dividend-producing assets, which are entitled to a special dividend tax credit if held outside an RRSP.

O'Donnell says bonds, GICs and interest-producing assets are best held inside an RRSP. That's because they're taxed the same as employment earnings. By holding them inside an RRSP, you'll pay tax when you withdraw the money, but in the meantime, they grow tax-free, allowing you to build a bigger retirement fund.

If your investments are out of kilter, you can consider an asset swap, putting bonds into your RRSP and removing risky stocks, but that is considered a sale and must be done at fair market value. Contact the financial institution that administers your RRSP for more information.

Jim Middlemiss is a freelance writer and lawyer based in Toronto. He's a frequent contributor to National Post, Investment Executive and Wall Street and Technology.

-- Posted: Feb. 25, 2004
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