October 11, 2023

5 RRSP mistakes and how to avoid them

By The Sun Life team

Ready for RRSP season? Here are some expert tips on what not to do with your RRSPs. 

Thinking about contributing to a registered retirement savings plans (RRSP) before the annual deadline hits?

There’s good reason to circle the cut-off date (it falls on February 29 in 2024). It’s your last chance to make a contribution that’s deductible against your taxable income. This means you could lower your previous year’s tax bill.

Another benefit of RRSPs beyond tax deduction is tax deferral. This means the investments you hold inside your RRSP can grow tax-free until you withdraw those funds from your account.

It makes investing in RRSPs sound simple. But mistakes can still happen.

There are ways to steer clear of issues or catch them before they become a problem.

Here are some tips to help you avoid 5 of the most common RRSP missteps.

1. Only putting cash in your RRSP

Did you know you can hold many types of investments in an RRSP? This includes stocks, guaranteed investment certificates, mutual funds, bonds and more.

Here’s a common scenario. In a scramble to make the deadline, you contribute cash to your RRSP. Then life takes over and you don’t get around to actually investing the money.

But RRSPs grow tax-deferred until you take them out. So investing the money will help you earn more over the long-term.

You may be leaving your contributions in cash if you’re short on time or don’t have a plan. In both cases, an advisor can help you build a plan and find a way to invest your assets. 

2. Making early withdrawals

Making RRSP withdrawals before retirement to cover bills or make big purchases can have lasting consequences. For one, you're giving up the years of tax-deferred growth your money would have generated inside your plan.

And secondly, you’ll face a double tax hit.

The first comes on withdrawal. You’ll have to pay an immediate withholding tax. 

Here’s a look at just how much.

How much withholding tax will you have to pay for RRSP withdrawals?
Withdrawal amount Percentage of withholding tax in all provinces (except Quebec) Percentage of withholding tax in Quebec
For the first $5,000 10% 5% federal + 15% provincial on a single withdrawal
For amounts between $5,000 and $15,000 20%

10% federal + 15% provincial on a single withdrawal

For more than $15,000 30%

15% federal + 15% provincial on a single withdrawal

Second, you may end up owing more at tax time. RRSP money is considered income by the government. This could bump you up into another tax bracket. 

Let’s say your marginal tax rate is 35% and you took money from your RRSP at (a withholding tax rate of) 10%. Then you’ll still owe 25% in taxes. 

This is why advisors always recommend you only withdraw funds from your RRSP as a last resort.

Is there any way to avoid the tax hit on early RRSP withdrawals? There is and it means withdrawing funds under the Home Buyers’ Plan or the Lifelong Learning Plan. These plans let you borrow cash from your RRSP for your first home or qualifying post-secondary education. But you must pay back the money you borrowed within a fixed timeframe.

3. Contributing too much

You can put up to 18% of your previous year’s earned income in your RRSP. That’s up to a maximum amount set annually. You can also carry forward room from previous years. (Your notice of assessment from the CRA spells all of this out in dollars and cents.)

That sounds like a lot of leeway, people go over the line occasionally. Company pension plans or deferred profit-sharing plans (DPSPs) are usually the culprit.

If you’ve contributed to a pension – defined-benefit (DB) or defined-contribution (DC) – it will decrease your contribution limit. Contributions to a DB or DC pension, as well as to a DPSP [even though a DPSP isn’t a pension], show up in the form of a pension adjustment in box 52 on your T4 slip. Often, people who over-contribute have a pension or a DPSP and they didn’t realize that these decrease their RRSP room.

It’s also important to note that you can over-contribute a lifetime total of $2,000 without penalty. The CRA allows this as a buffer against possible errors like ones from a pension adjustment.

4. Spending (instead of investing) the tax refund

Your RRSP contributions may result in a tax refund. So what happens if you reinvest this cash in your RRSP without over-contributing? Then you can trigger a happy growth cycle for your nest egg, thanks to the magic of compounding. Compounding is when you earn a return on your original investment and the return you received. It means more money in your account long-term.

If you spend your refund, though, you’ll miss this great opportunity.

5. Misunderstanding the RRSP succession rules

Another common error happens when people name an adult child as their RRSP beneficiary when they still have a living spouse or common-law partner.

But what if you have no living spouse or partner and you leave your RRSP to your estate? You still can’t escape the tax bill. The CRA will add the fair market value of the assets held in your RRSP to your income in the year of your death. This can trigger a significant tax bill for your estate that could diminish its value for your heirs. However, that tax can be deferred (meaning you won’t have to pay it right away) if you died leaving:

  • a financially dependent child or grandchild under 18, or
  • a financially dependent, physically or mentally infirm child or grandchild of any age.

But don’t let this keep you away from RRSPs. The key is to view your RRSP as a tool to sustain yourself in retirement, not to pass on a legacy.

Remember, the RRSP deadline for 2023 is on February 29, 2024. The CRA allows contributions for the previous tax year for up to 60 days after year-end. If you aren't already contributing to an RRSP, consider setting one up to start growing your nest egg. 

Need help figuring out what's right for you?

An advisor can help put together a solid plan that suits your goals

Mutual funds offered by Sun Life Financial Investment Services (Canada) Inc.

Sun Life Assurance Company of Canada is a member of the Sun Life group of companies.

This article is meant to only provide general information. Sun Life Assurance Company of Canada does not provide legal, accounting, taxation, or other professional advice. Please seek advice from a qualified professional, including a thorough examination of your specific legal, accounting and tax situation.

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