So You’ve Made Your RRSP Contribution: Now What?

It’s a classic mistake I’ve seen time and time again. You scramble to make your RRSP contribution before the deadline and then give yourself a giant pat on the back. But wait a minute. You’re not done yet. Not if your RRSP contribution is just sitting idly in cash.

You need to put that RRSP money to work.

Remember, you don’t actually “buy RRSPs”. Your RRSP is simply a container in which you can hold a wide variety of investments such as GICs, bonds, stocks, mutual funds, and exchange traded funds (ETFs).

It’s those investments that offer returns that hopefully beat inflation over time and provide you with a nest egg to draw from in retirement.

The RRSP container keeps those investment gains sheltered from the tax man until it’s time to withdraw the funds – the idea being that you’re in a lower tax bracket than you are when you made the contribution.

Your RRSP Contribution in Three Steps

Think of your RRSP as a three-step process.

1. Open an RRSP account (if you haven’t done so already) at a bank, credit union, investment firm, robo-advisor, or online brokerage account.
2. Contribute to your RRSP (transfer money into it from your chequing account).
3. Purchase the investment that aligns with the asset allocation outlined in your financial plan.

That allocation will be different for everyone. A conservative-minded investor might be happy with a 5-year GIC, while a do-it-yourself investor with a long time horizon might gravitate towards a globally diversified portfolio of mutual funds or low cost ETFs.

Related: DIY Investing Made Easy

The point of an RRSP contribution is not just to get a tax refund – although that’s indeed a juicy perk. Your RRSP is for retirement savings. Every day your money sits in cash is a day it’s not earning interest, dividends, or capital gains.

You’ve heard that compound interest is the eighth wonder of the world? Albert Einstein said, “He who understands it, earns it … he who doesn’t … pays it.”

The other issue with simply holding cash in our RRSPs is the temptation to raid it for short-term needs instead of using it for its intended purpose – retirement. Sure, there are legitimate reasons to withdraw money early from your RRSP, such as the Home Buyers’ Plan, or to cover a gap in employment or financial hardship.

But how many Canadians contribute to their RRSP during RRSP season (i.e. the first 60 days of the year), simply for the allure of a big tax refund? At best many of us spend the refund instead of putting it into our RRSP, TFSA, or to pay down our mortgage. At worst some of us spend the refund AND take out our initial RRSP contribution to fund vacations, cars, or just to make ends meet. Don’t laugh, I’ve seen it.

That’s right, many of us are raiding our RRSP savings well before retirement. Indeed, Canada Revenue Agency once reported that 55% of total RRSP withdrawals were made by Canadians under 60. That’s an alarming number of people raiding their retirement savings!

Taking money from your RRSP early is troublesome for three reasons. One, you’ll permanently lose that contribution room in your RRSP. Two, you’ll pay taxes on any withdrawals because the amount is included in your taxable income for the year. Finally, you’ll miss out on that tax-sheltered compounding that could have turned your $5,000 contribution into more than $21,000 (assuming a 6% return for 25 years).

For all of these reasons you’ll want to make sure to contribute to your RRSP this year and then complete the process by purchasing an investment product that fits your age and risk profile.

You’ll not only get closer to your financial goals, but you’ll make it that much harder to raid your retirement fund for something frivolous. If your RRSP contribution is just sitting idly in cash, it’s much more tempting to move it back into your chequing account – which is what we’re trying to avoid.