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RRSP mistakes to avoid

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(Special) - The Registered Retirement Savings Plan is an extremely popular vehicle for Canadians to save money on a tax-deferred basis for their retirement.

However, RRSPs are not a retirement panacea and there are some things investors should be aware of and avoid when it comes to their plans.

"It's really important to understand RRSPs, their benefits, why you should contribute and what you shouldn't do," says Chris Buttigieg, senior manager, wealth planning strategy with BMO Financial Group. "A lot of people make contributions but don't really understand some of the consequences of RRSPs such as early withdrawals and benefits like tax deferred growth."

Perhaps the biggest no-no associated with RRSPs is to withdraw money for any reason other than investing in the first time home buyers or the lifelong learning plans, which allow you to withdraw certain amounts of money from your RRSP to buy your first home or go back to school and repay it within a certain time without paying tax.

The government taxes other early withdrawals very heavily.

If you withdraw up to $5,000 you pay a 21 per cent withholding tax in Quebec and 10 per cent in all other provinces. Withdrawals between $5,001 and $15,000 are taxed at 26 per cent in Quebec and 20 per cent in other provinces and early withdrawals over $15,000 are taxed at 31 per cent in Quebec and 30 per cent in all other provinces.

And there are other penalties.

Once you withdraw the money it is considered income and will be added to your total income and you are taxed on that as well.

Once you've withdrawn the money it is removed from the contribution room available to you and you cannot re-contribute it later. If you've got $30,000 contribution room and take out $15,000, you're left with only $15,000 of contribution room.

And once the money is out you have to start over again to save it and you lose the compounding growth that you could have gotten if it had stayed in.

Many RRSP investors make their contributions to get their tax refund but end up leaving the money sitting in cash where it will make little or no interest. It makes sense to talk to a financial adviser about building a portfolio in your RRSP to maximize gains and limit risk.

"Once you've made your contribution and get your refund why not apply it some debt like a mortgage or invest it in a Tax Free Savings Account - it's like hitting two birds with one stone," Buttigieg suggests.

Many people also do not pay attention to their notice of assessment from the tax department after they`ve filed their income tax which shows their RRSP deduction limit. You can over-contribute up to $2,000 for a year, but after that you are assessed a one per cent per month penalty.

If for some reason you forget to claim your contribution for the year or if you have built up unused contribution room, it can be carried forward to future years indefinitely. In fact, if you think you will be making more money in the future and will be taxed in a higher bracket, it might make sense to make the contributions but wait till then to claim them.

Many people also overlook dedicating a beneficiary for their RRSPs. If an RRSP holder dies and does not have a designated beneficiary such as a spouse, partner or dependent children it can be transferred to the individual's estate and becomes subject to probate fees and becomes fully taxable.

"A lot of people simply make the mistake of not thinking about their retirement goals early enough in life and not developing a strategy for what to do with their RRSP savings," Buttigieg says.

Talbot Boggs is a Toronto-based business communications professional who has worked with national news organizations, magazines and corporations in the finance, retail, manufacturing and other industrial sectors.

Copyright 2014 Talbot Boggs

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