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
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
"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
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
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.