Financial Friday #106: RRSP, TFSA & RESP Fails to Avoid!
7 Surefire Ways to Fail with Registered Accounts
Canada has a number of "registered accounts" to help Canadians save for retirement, post-secondary education & training, or the down payment on a home. The most common registered accounts are the TFSA, RRSP, and RESP. Each one has a unique set of rules and regulations, but all of them are easy to open and many people take a DIY approach to managing the investments held in their registered accounts. However, there are some common misconceptions and pitfalls to avoid, so make sure to give the seven mistakes below a quick review.
1. Getting started late and underestimating the power of compound interest.
The average annual return from the stock market over the last 50 years is around 7%. Depositing $100 a month into a TFSA for the 47-year period between age 18 and 65 at 7% would put just under $400K tax-free in your retirement fund. If you were able to increase your monthly contribution to $300 ($500 is the monthly limit) from age 45 to 65, you would have over half a million tax-free dollars!
2. Getting discouraged by annual contribution limits.
The annual contribution limits for registered accounts are unattainable for a lot of folks, but don’t let that discourage you in any way! As you learned above, even $100 a month goes a long way if you start early. Currently you can contribute $6000 year to your TFSA, 18% of your earned income to your RRSP, and $2500 per year for each child to their RESP. That’s way more than most of us have, so just figure out what you can afford and which registered account is best suited for your situation.
3. Choosing the wrong account.
The majority of confusion comes from whether an RRSP or TFSA is the best option. The simple answer is that neither is a bad choice and you should max out both if you can. A TFSA often has the edge because it grows tax free and offers more flexibility to withdraw funds than an RRSP. On the other hand, the RRSP lets you keep more money in your pocket (for now!) by deferring taxes and also offers a Home Buyers’ Plan. Unless your situation is overly complex, a little research should allow you to sort out the best option.
4. Not having one at all!
Although they are free and offer many tax benefits, only around 60% of Canadians have a TFSA and just over 50% have an RRSP. Having trouble finding the cash? Try setting up an automatic transfer from your chequing account to put $100 every payday into your TFSA and make that money invisible – you can’t spend what you don’t see! Contributions up to $2500/year into your child’s RESP receive a 20% Canada Education Savings Grant (CESG) — it’s free money! Try skimming a little each month from your CCB cheque if you are having trouble coming up with the cash to fund your RESP.
5. Holding too much cash and not monitoring your risk and return.
Registered accounts truly shine when they are used as intended – for investing, not parking cash! Cash is risk-free but offers a terrible return, especially given current inflation and cash deposit interest rates. You can adjust the investments you hold to match your risk preferences and you should evaluate the overall risk and performance of your portfolio at least once a year to confirm it is in line with your current expectations and life situation (age, income, retirement goals, etc.)
6. Getting blindsided by management fees.
Seemingly low annual "management fees" (like the MER on many mutual funds) of 2% (or more) on your investments will compound over the years to take a massive bite out of the investments in your registered accounts. Don’t be persuaded to believe that the more you pay in fees, the higher the return you will get. This situation rarely materializes in real life as even the "experts" have trouble consistently beating average market returns over the long term. There are lots of low-cost DIY investment options with fees well under 1% that require limited financial knowledge and very little time to manage on your own. Keep reading this newsletter for details of several free webinars on basic DIY investing coming up in late-April and May.
7. Not checking the rules.
If you run a fowl of the rules it is going to cost you — the CRA will not let you wiggle out of it. There are annual contribution limits, contribution deadlines, rules and penalties for early withdrawal, and plenty of other stipulations that you need to follow. The good news is there is plenty of information available to help you (the government websites are great).
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