February 17, 2014

Six RRSP Traps to Avoid

It’s that time of year again when many investors look at their portfolios and make their annual RRSP contributions. The variety of investment options can be stressful and confusing, causing some investors to make hasty decisions about their contributions.

The most effective way to avoid the stress of making an RRSP contribution by the March deadline is to contribute monthly. It eliminates the need to come up with a large sum of money all at once. By making regular contributions throughout the year, you benefit from market volatility by buying more units when markets are down and securities are less expensive. This is called dollar cost averaging. In addition, you may be able to reduce the tax you have withheld at source from your employer if you can prove you are contributing regularly to your RRSP.

Whether you're topping up your RRSP before this year's contribution deadline, or planning a strategy for the coming year, below are a few traps to avoid when making your RRSP contribution. By spending a few minutes now and avoiding these common mistakes, you make your retirement planning more effective.

Trap 1: Being fooled by misleading advertisements.

As the wise lady in the B.C. Securities Commission TV ads warns, there is no such thing as risk-free investments that promise a high return. Read the fine print. Use of the words “guaranteed” and large return promises attract attention, but they often have a catch and the actual return can be much lower than expected or the cost of the guarantee can be very high.

Trap 2: Assuming that what performed best last year will be the leader this year.

Don’t base your investment decisions on the vehicle that had the best return last year. It is highly unlikely you’ll see those returns this year. Always make your investment decisions after carefully considering your investment objectives, time horizon and risk tolerance. An asset class or security that had a phenomenal year in 2013 probably won’t be the market leader in 2014.

Trap 3: Parking your money in cash until you can invest it sometime later.

If you have waited all year to make your contribution and you put your money in cash or a money market fund in order to get the tax receipt, you might end up leaving your money there longer than anticipated. If you are investing in your RRSP for the long-term, cash is not an appropriate asset class. Take a few minutes now to invest the funds in a way that gives you a suitable asset mix.

Trap 4: Ignoring fees.

Fees matter! Many mutual funds have high annual fees (known as the Management Expense Ratio or MER) that are charged to the fund directly. But, some funds also have additional fees that limit your ability to sell or transfer out without incurring large charges. Know what the costs are upfront. Is there a fee to buy or sell and how much are you paying annually including any administration costs? High fees will have a significant impact on your long-term returns.

Trap 5: Failing to ensure your advice is objective.

You’ve worked hard to earn the money that is in your RRSP. Make sure your advisor has your best interests in mind when making a recommendation for your portfolio. Ask how your advisor is compensated. If your advisor is paid a commission by a mutual fund company to sell its products, is that advice objective?

Trap 6: Lumping your RRSP with your TFSA.

Don’t assume you have to choose to invest in an RRSP or a TFSA. RRSPs and TFSAs are both great vehicles that provide tax-sheltered growth of earnings. Both should be part of your investment strategy. RRSPs provide a tax credit upon contribution and amounts withdrawn need to be included in income at that time; TFSAs don’t provide a credit but withdrawals are not taxable. Ideally, both should be part of your portfolio.

This article is not intended to provide advice, recommendations or offers to buy or sell any product or service.  The info provided in this article is compiled from our own research and is based on assumptions that we believe to be reasonable, accurate at the time the report was written, but, is subject to change without notice.