RRSP in an acronym for "registered retirement savings plan." This definition sounds mighty dry when you consider how RRSPs are superheroes of modern retirement planning for Canadians—true tax-obliterating, retirement-enriching wonders of the modern world.
An RRSP is what's called a tax-advantaged account, meaning that the government created them to specifically provide tax breaks to those who invest money in RRSPs as a way to motivate them to put away savings for their retirement.
What exactly is the meaning of the term “tax-advantaged”? To you, Canadian taxpayer, tax advantaged means in practice “free government money.”
In this specific case, RRSPs are what’s called tax-deferred, meaning any money you contribute will be exempt from CRA taxes the year you make the deposit and will only be taxed years down the line when you withdraw it. RRPs are an amazing way to cut down a current-year tax bill.
Here’s how a tax-deferred account like an RRSP works. Let’s say you make 70,000 a year and you decide to put the maximum allowable into your RRSP—$12,600. When tax day comes around, the CRA will treat you as though you earned just $57,400. Now, tax-deferred doesn’t mean tax-free. You will eventually have to pay taxes when you withdraw you money years down the line, but by the time you do so, you’ll be retired and your income will almost certainly be smaller. Thus, your tax rate will be lower than it is now.
Because RRSPs are registered accounts, they are subject to certain rules. One of the most important rules concerns the amount of money you can contribute to the account in any given year; it’s either 18% of your past year’s income or a maximum amount, whichever is smaller.
The amount changes. You can also catch up if you didn’t max out your investments in earlier years; to find out how much you can contribute, check out the Notice of Assessment that you received after filing your taxes in the previous year. It is important to remember that even though you might have contribution room left over from previous years, you will not accumulate deduction limits. So imagine you have made 36,000 into your account, but you’ll only be able to deduct 18,000 of income from your current year taxes.
Only one letter separates the RRSP from the GRRSP, but that one letter could mean a difference of tens, even hundreds of thousands of dollars in retirement. Group RRSPs are just company-administered RRSPs. And though they have a few disadvantages, like limited investment options and possibly higher fees, they have one extraordinary advantage—employers will often match a portion or even every dollar of your GRRSP contribution.
With this this in mind, you might think of your retirement savings as one of those fabulous champagne towers that you’ve never actually seen at any wedding you’ve personally attended. The top cups always get filled first before anything below gets even a drop of champagne. If money is the champagne in this metaphor, the absolute tip top cup should be your employer’s GRRSP. That free-for-the-taking employer matching contribution will make an extraordinary difference in terms of compounding gains over the long term. And because you can have your employer withhold funds to deposit directly into your GRRSP, not only will you not be tempted to spend that portion of your pay, the money deposited will be pre-tax, meaning that a larger amount of money will get invested right away versus investing yourself and having to wait six months to a full year to get that money back though a tax refund.
Since both TFSAs and RRSPs are phenomenal in their respective ways, this a kind of a Batman vs. Superman question, one that begs the question why you should have an RRSP when a TFSA is similar and has no early withdrawal fees.
Here are a few of the biggest factors to consider:
If you haven’t contributed much towards your retirement and you happen to have access to a pile of money right now through, say, a bonus, or inheritance, a TFSA might be the best option for you, since RRSPs have what's called an annual deduction limit, meaning that you won't be able to deduct over a certain amount in any given year. The number for 2021 is $27,830 but you can find past, current and future deduction limits on this CRA page.
TFSA are designed to be easily accessed before retirement if the funds are needed—which is good, especially for those with a more immediate goal in mind like buying a house or car. TFSAs are less good if you happen to be the type who’s never been able to resist smashing a piggy bank.
If the funds are for your retirement, for tax reasons, TFSAs are generally considered preferable to RRSPs for those earning less than $50,000 a year.
What happens if you contribute too much to your RRSP? The CRA’s pretty forgiving on these matters. First, you’ll get a nice bit of cushion; any amount up to $2,000 over your annual limit will be forgiven (though it won’t be considered tax-deductible). If you go over that, the CRA will likely mail you a notice that you’ve over contributed and encourage you to vamoose that excess dough. Should you fail to, they’ll begin to assess a penalty of 1 percent on that over-contribution, assessed monthly, for each month you‘re over the limit. The CRA understands that mistakes happen, and should you find yourself in this situation, it may be worthwhile to do a bit of research on the topic of penalties and resolutions and seek forgiveness of this penalty.
Though RRSPs are often regarded as an impenetrable lock-box of retirement savings that will explode in your face if you try to access it before retirement, the Home Buyers Plan (HBP) provides one notable exception to that idea. The HBP, a program through the Canada Revenue Agency (CRA), allows eligible first-time homebuyers to withdraw up to $35,000 tax-free from their RRSP to be used towards a down payment on the purchase of the home. So, you can take advantage of the tax deductions that RRSP contributions provide while saving for a down payment on your home. Then, you can withdraw the funds tax-free and use them towards buying a home. But one thing you must remember: because HBP is like you loaning yourself money for a house, there are rules with great tax-implications you’ll need to follow. Since they’re a heck of a lot more accessible than RRSPs, if you’re pretty sure you’re going to be buying your first house soon, a TFSA might be the wiser account for your needs.
Who introduced RRSPs? RRSPs have been around since 1957 and were introduced by the federal government. Their aim was to help Canadian's save for retirement by providing them a tax-deferred savings plan.
Who’s eligible for an RRSP? Opening an RRSP is super easy. The only conditions for eligibility are that you’re under 71 years of age, are a Canadian resident for tax purposes, and file income taxes in Canada. Minors under the age of 18 can set up an RRSP with written parental consent (or that of a legal guardian).
How much will having a RRSP reduce my taxes? Since you can contribute up to 18% of your past year’s income, you could avoid paying tax on that portion of your income if you contribute the full amount every year. Also keep in mind that when you begin withdrawing from the RRSP during retirement, you’ll pay less money on that income because you’ll likely be in a lower tax bracket.
How much will my RRSP be worth/grow? The value of your RRSP depends on how much you’ve contributed each year, what assets your RRSP is invested in, and how many years you’ve had the account for. However, average rates of return for retirement accounts tend to hover between 4% to 8%.
What happens to your RRSP when you retire or die? When you retire, your RRSP turns into a Registered Retirement Income Fund (RRIF) that you can withdraw money from (income tax would apply to any withdrawals). If you die, however, your RRSP is usually rolled over to a beneficiary on a tax-deferred basis. The beneficiary would be designated by you, but if no beneficiary has been named then the proceeds fo your RRSP are considered part of your estate and will be distributed accordingly.
Can an RRSP be transferred to another person (partner/child)? An RRSP can’t be transferred to another person while the account holder is still alive, but you can open a joint RRSP with a spouse. As a rule, you can’t transfer money from your RRSP to someone else’s RRSP while you’re still alive.
Does contributing to an RRSP affect OAS? Contributing to an RRSP doesn’t affect Old Age Security (OAS). Where you need to watch out is when you start withdrawing from your RRSP. Once your net taxable income during retirement reaches a certain level, your OAS be subject to a recovery tax, also known as the “clawback.”
How do you find your RRSP issuer or manager? Many financial institutions (including this one) offer RRSP accounts. You simply sign up with the investment provider of your choice and then regularly deposit contributions to your RRSP via the institution managing your RRSP.
What is RRSP matching? RRSP matching usually takes place in Group RRSPs, which are RRSPs managed by your employer. Through them, your employer may choose to match your contributions to the RRSP, which means you’ll be doubling your savings and racking up tax savings.
Can an RRSP be withdrawn at any time? You can withdraw from your RRSP before you turn 71, but those withdrawals will count as income—meaning you’ll be taxed on the amount at a higher tax rate than you probably would if you withdrew it during retirement. You will also be charged a withholding tax, and you’ll permanently lose the contribution room you used to originally make your deposit.
Can RRSP contributions be carried forward? Your RRSP contributions can be carried forward. Any unused contribution room can indefinitely be carried forward to future years.
Can an RRSP be transferred to a TFSA? You can transfer funds from an RRSP to a TFSA, but it’s a two-step approach. First, you’ll need to withdraw the funds from your RRSP, which means you’ll be subject to a withholding tax and income tax on the amount withdrawn. You can then deposit those funds in a TFSA but you need to make sure you have enough available contribution room.
Can an RRSP be used to buy a house or for your education? You can use your RRSP to buy a house if you’re a first-time homebuyer through the Home Buyer’s Plan, and you can use your RRSP to pay for your education through the Lifelong Learner’s Plan. RRSPs can also be used as collateral for a loan, but it’s not considered advisable since it could lead to a higher tax bill.
Can an RRSP offset capital gains? An RRSP can offset capital gains from other sources if you have enough contribution room available. You don’t have to worry about capital gains in an RRSP itself because those investments are tax-sheltered.
Can an RRSP be garnished? Whether or not your RRSP can be garnished—ie. claimed by creditors—depends on what province your account is held in and under what circumstances it’s been opened. However, RRSP proceeds are usually protected under the The Bankruptcy and Insolvency Act, excluding any contributions made within the last 12 months.
