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Potholes on the road to retirement

Ram Balakrishnan bought high-flying stocks in his RRSP. When they lost value, he lost contribution room.

Brigitte Bouvier for The Globe and Mail

MISTAKES

Potholes on the road to retirement

Nobody said investing for the golden years is easy. Here are eight RRSP pitfalls to avoid

Larry MacDonald

We all make mistakes. When it comes to registered retirement savings plans, Ram Balakrishnan has made a few. One of the biggest was buying high-flying stocks such as JDS Uniphase, Nortel, Intel and Yahoo inside his plan.

"When these stocks crashed and burned, as high-risk stocks are likely to, valuable contribution room was lost," says Mr. Balakrishnan, an Ottawa engineer who writes a personal finance blog, Canadian Capitalist.

"Had they been held in taxable accounts, I would at least have had capital losses that could be carried indefinitely into the future."

You've got to be smart to earn a master's degree in electrical engineering, as Mr. Balakrishnan did. If he slipped up in his RRSP moves, chances are many of us have made mistakes, too - and will likely do so again, unless we become familiar with how RRSPs can go awry. Here's a look at eight common pitfalls.

Wrong beneficiary

If you opened an RRSP a long time ago, you may have forgotten who was named as beneficiary. It could be your ex-spouse or your dear departed mother, for all you know. If an RRSP is to be transferred upon your death without incurring taxes, a qualified beneficiary must be designated, specifically a current spouse or financially dependent child or grandchild.

The dreaded clawback

Low-income earners near retirement can reduce their entitlement to government old-age benefits if they contribute to an RRSP. The Guaranteed Income Supplement could be lost, as well as Old Age Security payments in part or whole. Other benefits, such as subsidized housing and subsidized nursing care, may be affected, too.

The good news in 2009, however, is that the new Tax Free Savings Account (TFSA) allows those with low incomes to save for retirement without having to worry about clawbacks.

Paying too much tax

Being super-thrifty on a low income can be disadvantageous if RRSP savings grow to a size that puts retirement income into a higher tax bracket. To avoid this, young people in low-income jobs can make contributions to their RRSPs but not take the tax deduction at time of contribution. Instead, they can carry it forward to a year when they will be in a higher tax bracket.

Low-income earners near retirement are less able to exercise this option, of course. But they (and younger people, too) can accumulate savings in a TFSA or pay off debt. High-interest-rate debt on credit cards and car loans should always be paid off before contributing to registered savings plans, experts advise.

Asset misallocation

Generally, income-producing investments such as bonds are best carried in an RRSP while growth investments such as stocks are best left outside.

"It does not make much sense to fill your RRSPs with risky investments. If you lose a lot of money you cannot claim a capital loss," says Warren MacKenzie, chief executive officer of Toronto-based Second Opinion Investor Services. "Also, once the money is lost you might not be able to replace it because you are limited to how much you can contribute to RRSPs."

Moreover, if capital gains occur, the lower tax rate on them is forfeited: when you withdraw from your RRSP, those gains are converted to fully taxed income. Dividend stocks are good to leave outside RRSPs, too, because of the dividend tax credit (except for foreign dividend stocks, which are not eligible for the credit).

Contributing too much

Some investors don't check the RRSP contribution limit that is shown on their previous year's tax assessment notice, or may fail to do the calculations properly. If your contribution is over the limit by more than $2,000, interest is charged at a rate of 1 per cent a month.

An over-contribution of less than $2,000 might be seen as a good thing given that the amount accumulates tax-free. However, if you later make a withdrawal, the result could be double taxation - tax paid on the withdrawal, and tax not refunded on the over-contribution.

Neglecting repayments

If you withdraw money from your RRSP under the Home Buyers Plan or the Lifelong Learning Plan, you must repay that amount pack to you plan according to a prescribed schedule. If not, the missed payments are taxed as RRSP income. Perhaps more important, tax-sheltered compounding of growth is lost.

In-kind transfers

"In-kind transfers of investments with an unrealized capital loss, from a non-registered account to an RRSP, might cross the minds of more than one Canadian in 2009," says Preet Banerjee, a senior vice-president with Pro-Financial Asset Management, based in Oakville, Ont.

"The problem is that you won't be able to claim the capital loss for tax purposes if you make this in-kind RRSP contribution." It's better to sell the securities first in the non-registered account to qualify for a capital loss, and then contribute the proceeds to an RRSP.

Fees on foreign holdings

Some investors pick the wrong RRSP to hold foreign investments. Many sponsors of self-administered RRSPs charge currency-conversion fees to buy and sell foreign securities. Some don't. If you do a lot of investing in foreign markets, it might be worthwhile to go with the latter.

Special to The Globe and Mail

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