In Canada, a Registered Retirement Savings Plan (or RRSP for short), is an investing and retirement savings account that is registered with the Canada Revenue Agency (CRA).
The federal government of Canada created RRSPs in 1957 as a way to help Canadians save for retirement.
The RRSP is a tax-advantaged account, meaning that the government created these accounts specifically to provide tax breaks to Canadians who use these accounts to invest or put money aside for retirement purposes.
In other words, the biggest benefit of the RRSP is that the taxes on RRSP contributions are deferred until retirement, allowing Canadians to have more money invested and growing without being taxed.
For example, any extra money that you put towards an RRSP is not taxed as part of your annual income for that year, so you would pay less income tax for that year.
This is just one of the many benefits of an RRSP that you may not have known about. Here are 5 other little-known facts about RRSPs that you should know.
An RRSP is Different From a Typical Savings Account
When it comes to saving money, the first thought that comes to mind is heading down to your local bank and setting up a savings account where you can deposit any extra cash.
Over time, as you deposit more money into the account and get paid additional interest from the bank, your savings will grow.
While it is possible to deposit money into an RRSP, it is not the only way to grow your retirement savings.
The tax-advantaged benefits of having an RRSP are maximized when investments are placed in these accounts as any growth of your investments (either in stocks, bonds, ETFs, etc.) is not taxed until you withdraw your money.
According to Investopedia, there are many different types of investments that are allowed in an RRSP including Mutual Funds, Exchange-Traded Funds (ETFs), Equities, Bonds, Savings Accounts, Mortgage Loans, Income Trusts, Guaranteed Investment Certificates (GICs), Foreign Currencies.
For reference, when investing in accounts that do not have tax-advantaged benefits, a “capital gains” tax may apply when you sell your investments.
This means if your investment grows and you wish to sell it, you may be taxed a certain percentage of the investment when you sell the asset at a profit.
On the other hand, in an RRSP, your investments will not be taxed should you wish to sell the investment at a profit. You will only be taxed when you decide to withdraw money from your RRSP.
The tax advantages of an RRSP can be thought of as in two-time frames:
- Upfront Tax Advantages
- The upfront tax advantage of an RRSP is that at the same time as you are putting away money for retirement, you will also be reducing the income you will pay tax on for that given year
- For example: Let’s imagine that you earn a salary of $80,000 per year and you decide to contribute your allowed maximum into your RRSP which happens to be $15,000.
- When it comes time to pay your taxes, the CRA will only tax you for the $65,000 of income ($80,000 annual income – $15,000 RRSP contribution = $65,000 taxable income)
- Future Advantages
- Any growth in the investments in your RRSP will not be taxed until you decide to make a withdrawal from your RRSP
- This withdrawal usually happens during your retirement when you are in a lower tax bracket as a result of no longer being in the workforce
Pay Attention to Your RRSP Contribution Limits
While the tax-advantaged benefits of the RRSP are a great reason to allocate extra money into saving for retirement, there are some things you should consider before putting all your money in an RRSP.
A slight drawback to RRSPs is that there is a contribution limit, meaning there is a maximum amount of money that you can put aside in your RRSP each year.
What is your RRSP contribution limit? It depends, but the CRA generally calculates your contribution limit based on 3 factors:
- The total unused deduction room from the previous year
- The smaller amount of either:
- 18% of the earned income you reported last year
- $21,830 (the annual contribution limit for 2021)
- Any pension adjustments from the previous year
While this is a lot of information to take in, the important thing to know here is that the contribution limit depends on how much money you put in your RRSP last year, the amount of income earned last year, and the annual contribution limit for the year.
To find the exact amount, you will need to refer to the T1028 Form from your tax returns or visit the CRA website.
Bonus Fact: What Will Happen If You Go Over the RRSP Limit?
Over-contribution to an RRSP can happen from time to time and may usually be forgiven but to a certain extent.
According to WealthSimple, any amount up to $2,000 over your annual contribution limit usually would not be penalized by the CRA. However, any amount over $2,000 is when the CRA may get involved.
When it comes to contributing over this limit, the CRA will likely be sending home a notice of an over-contribution to the RRSP, followed by an encouragement to either withdraw a certain amount or pay a penalty of 1% of the excess amount contributed each month you are over the limit.
The tip here is to always check in with the CRA on what your contribution limit is and keep up to date on how much you are allowed to allocate to your RRSP to avoid these penalties.
There Are Different Types of RRSP Accounts, What is Best for You?
While there are several different types of RRSP accounts, what makes them different is how they are set up, usually by one or two associated people (either individuals or spouses).
Here are a few different types of RRSP accounts to consider when deciding on opening an RRSP:
- Individual RRSP
- An Individual RRSP is set up by a single person who is both the account holder and the contributors
- Spousal RRSP
- A Spousal RRSP provides benefits for a single spouse and also a tax benefit for both spouses
- For example, a high-earning spouse (spousal contributor) may contribute to a Spousal RRSP in their spouse’s name (the account holder).
- Since the retirement income is divided evenly, each spouse can benefit from a lower marginal tax rate
- Group RRSP
- A Group RRSP is usually set up by an employer for employees and is funded with payroll deductions
- For this type of RRSP, the account is administered by an investment manager but continues to provide contributors with the advantages of immediate tax savings
- Pooled RRSP
- Pooled RRSP is an option that may be available for small business employers and employees as well as for those who are self-employed and do not have access to a workplace pension
Can You Withdraw From your RRSP Before You Want to Retire?
Absolutely! You can withdraw money from your RRSP at any time. However, there are some important considerations you need to know about when it comes to withdrawing from your RRSP early (meaning before you retire).
Firstly, as mentioned before, there will be an upfront withholding tax involved and the amount that you are withdrawing from your RRSP will be added to your taxable income in that year.
For example, let’s say your annual salary is $60,000 and for that year you have not contributed to your RRSP at all. This year you decide to withdraw $5,000 from your RRSP.
The $5,000 withdrawn will be added to your taxable income ($60,000) and you will have to pay applicable taxes for an annual income of $65,000 for the year you have withdrawn money from your RRSP.
Secondly, you will permanently lose your contribution room for the amount you have withdrawn. In other words, you will no longer be able to get back the $5,000 contribution room from your RRSP once you have withdrawn this amount.
There are two exceptions to this however, with certain limits, you can withdraw funds from your RRSP tax-free and can recontribute this amount for two situations:
- You are Buying Your First Home
- As part of Canada’s Home Buyer’s Plan, you can withdraw up to $35,000 tax-free from your RRSP to buy or build your first home.
- The catch to this is that you must re-contribute the amount that was taken out for the down payment over 15 years or you will be taxed on it
- The 15-year repayment period begins 2 years after the calendar year in which you have withdrawn the funds.
- You Are Withdrawing Money for Education
- Through Canada’s Lifelong Learning Plan, you can withdraw a maximum amount of $20,000 to fund your or your spouse’s education
- You can only withdraw $10,000 per year and must re-contribute the amount withdrawn over 7 years or you will be taxed on it.
Aside from these two purposes, withdrawing money early from your RRSP will result in the loss of your contribution room.
Are There Any Other RRSP Contribution Rules?
In addition to contribution limit rules, there are three general rules when it comes to RRSP contributions:
- You can contribute until December 31 of the year you turn 71 years old
- You can contribute what you have available in your contribution room provided by the CRA
- There is an RRSP contribution deadline, usually March 1 of each year, to contribute to your or your spouse’s RRSP to be eligible to claim a deduction on your tax return
With all these RRSP rules, considerations, and tips in mind, you are well on your way to retiring comfortably.
As everyone’s financial situation is different, please be sure to continue to do your research and speak with your financial advisor to find what works best for you.
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