Yahoo Finance Canada Revenue Agency: 1 RRSP Mistake That Could Cost You Dearly
If you have an RRSP, you’re probably well aware of the importance of contributing as much as possible. After all, there are tax deductions and tax-free growth up for grabs. Over the long run, investing in an RRSP can save you some serious coin.
It’s true that not putting money into your RRSP is, in most cases, a mistake. There are, however, situations where making contributions would be an even bigger mistake.
In this article, I’m going to explore one situation where adding extra money to your RRSP could cost you big time — not at some point in the future, but today.
Contributing past your limit
Every RRSP has a certain contribution limit — generally 18% of earned income up to a set maximum. You’re probably aware of this fact. What you may not be aware of is the heavy cost of going over it.
According to the Canada Revenue Agency (CRA), excess funds contributed to an RRSP are taxed at a rate of 1% per month. Unlike other RRSP taxes, which are deferred until withdrawal, this tax becomes effective immediately and begins eating into your balance. The tax has to be paid within 90 days of the time it’s issued, so your funds will start getting depleted in short order.
What a 1% a month tax could add up to
That 1% a month can add up to quite a bit over the course of a year.
Consider the case of someone who had over-contributed to their RRSP by $10,000. The first month after over-contributing, they’d be on the hook for $100. The next month, they’d have to pay $99. The month after that, $98.01.
After 12 months, the $10,000 balance would have shrunk to $8,863.
What to do to avoid this trap
The easiest way to avoid over-contributing to your RRSP is to look at the RRSP limit given on your CRA account.
The CRA has access to information from your bank, so this figure is guaranteed to be accurate.
This step alone is enough to avoid over-contributing.
But what if you want to reach a certain RRSP balance and can’t get there without over-contributing? In this case, you still have a problem, because the RRSP contribution limit is keeping you from your retirement savings goal.
One strategy to get around this is to buy dividend stocks in your RRSP. Dividend stocks with stable payouts add cash to your RRSP without you having to add it from outside. This lets you accumulate a larger RRSP balance — even in bear markets — without making deposits.
A great stock for this strategy is Fortis. Fortis is a Canadian utility with operations in Canada, the U.S., and the Caribbean. As a utility, it has an ultra-stable revenue stream owing to the indispensability of the services it provides. Even during recessions, people don’t usually cut out home heating, so this is a rare company that can keep up its dividend through recessions without cutting them.
Fortis’s history proves that this is indeed the case. The company has increased its dividend every single year for the past 46 years — a period that includes many recessions. This proves that the company can keep cranking out income even in down markets. So, if past trends continue, it could be effectively relied on to increase your RRSP balance without you having to make excess contributions.
More reading
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Fool contributor Andrew Button has no position in any of the stocks mentioned.
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