A great deal of attention is focused on what to buy in your RRSP at this time of year. But what about the investments that you shouldn’t make?
When it comes to what to avoid, there are three primary considerations: income tax, product selection and investment strategy. Here’s how to take each potential pitfall into account before making a mistake with your investments this RRSP season.
Buying Canadian mutual funds or exchange-traded funds (ETFs) that hold non-Canadian stocks, like U.S. or international stocks, can be a bit of a drag. This is because U.S. and international withholding taxes on the investment income earned by a Canadian fund create a drag on your investment performance. Most countries levy a 15 per cent withholding tax on dividends — meaning, for example, you will lose nearly half a per cent of the current return of the Europe, Australasia, Far East (EAFE) index yield of 3.17 per cent.
If possible, consider U.S.-listed stocks or ETFs as alternatives. U.S.-listed stocks are not subject to withholding tax when held in an RRSP. U.S. ETFs that hold U.S. stocks will not be subject to withholding tax either. But, U.S. ETFs holding international stocks will be.
Even though U.S. stocks will be tax-exempt in your RRSP, U.S. listed American Depositary Receipts (ADRs) for foreign corporations listed on a U.S. stock exchange will still generally be subject to withholding tax. The most common rate is 15 per cent on foreign dividends.
That said, you should not ignore U.S. or foreign investments solely to reduce tax withholding at the expense of proper portfolio diversification. Simply consider alternatives and understand the implications.
Beware high fees on your investments. Canadian mutual fund fees are coming under pressure from lower fee alternatives like ETFs and robo-advisers, but still frequently weigh in at over two per cent annually. In a low yield environment like the one we’re in currently, paying more than two per cent on your investments when the fixed income portion of your portfolio might only be generating two per cent returns means you are treading water net of fees if you are a conservative mutual fund investor.
Look out for deferred sales charge (DSC) mutual funds as well. A good investment adviser at a good investment firm should not have to tie your hands with these fees of up to six per cent that may apply if your mutual fund is held for less than seven years.
Diversification is important in an RRSP. As do-it-yourself investing has increased, so too have DIY mistakes. Investors looking to stick it to the mutual fund industry sometimes stick with just a few stocks or just a few industry sectors within their self-directed RRSP. The one good thing about mutual funds is that they are diversified.
If you are going to build your own mutual fund by purchasing individual stocks, at least try to build an RRSP to ensure that no more than five per cent of your portfolio is invested in an individual stock. Furthermore, target a diversified exposure across sectors and geographies. The key is that you should not build an RRSP with only a few stocks or sectors.
This RRSP season, despite all the advice about what you should be buying, consider some of the things to try to avoid for your retirement savings. By saving taxes, minimizing fees and reducing risk, you can help boost your RRSP returns over the long run.
Jason Heath is a fee-only Certified Financial Planner (CFP) and income tax professional for Objective Financial Partners Inc. in Toronto, Ontario. The article “Watch Out For These Three Potential Pitfalls When Planning Your RRSP Investments” was originally published on The Financial Post on February 16, 2016.