Registered Retirement Savings Plan (RRSP) season is just around the corner. Beyond the importance of growing funds for retirement, avoiding certain practices can help to save tax or create a bigger nest egg for the future. Here are five RRSP pitfalls:
1. Withdrawing funds to pay down debt — Consider the implications of making taxable withdrawals from the RRSP to pay down short-term debt. You may be paying more tax on the RRSP withdrawal than you’ll save in interest costs. In addition, once you make a withdrawal from the RRSP, you won’t be able to reinstate the valuable contribution room — unlike the TFSA, where a withdrawal is added back to contribution room in the following year.
2. Contributing losers in-kind — In order to fund the RRSP, some may choose to move investments from non-registered accounts. If you are considering making in-kind contributions to the RRSP, be careful not to transfer investments that have accrued losses. You will be deemed to have sold these investments at fair market value at the time of transfer to the RRSP, yet the capital loss will be denied and any tax relief lost. Instead, consider selling them on the open market and contributing cash to the RRSP so you can claim the capital loss (and, again, be aware of the denied loss rules, thus do not repurchase the investment for 30 days).
3. Claiming the deduction in the wrong year — With any RRSP contribution, you’re entitled to claim a tax deduction for the amount so long as it is within the contribution limit. Keep in mind that you don’t have to claim the tax deduction in the year that the contribution is made. You may carry it forward if you expect income to be higher in future years such that you may be put in a higher tax bracket, potentially generating greater tax savings for a future year.
4. Neglecting to update beneficiary designations — It may be beneficial to review account beneficiaries (in provinces where applicable) periodically and in light of major life changes. For example, in the event of separation or divorce, be aware that named beneficiaries may not be revoked, depending on provincial laws. Therefore, the designation of an ex-spouse may still be in effect.
5. Withdrawing from a spousal RRSP — For couples in which one spouse will earn a high level of income in retirement, while the other may have little income, a spousal RRSP may be a valuable income- splitting tool. Yet, don’t forget that the attribution rules generally apply to a spousal RRSP. If the higher-income spouse has made contributions to the spousal RRSP in the year, or immediate two preceding years, and if funds are withdrawn from the plan, they may be taxed to the higher- income spouse, as opposed to the lower-income spousal RRSP owner.
