Everything You Need to Know about RRSP’s

RRSP stands for Registered Retirement Savings Plan. An RRSP is a registered investment account, meaning it’s registered with the Canadian government to receive special tax privileges. RRSP’s were introduced by the Canadian government in 1957 as a way to encourage Canadians to save for retirement.

Any Canadian resident who files income taxes in Canada under the age of 71 may open an RRSP. Though many people feel they don’t need to start saving for retirement until later in life, opening an RRSP in your 20’s or 30’s actually provides the greatest level of tax advantage a person could have. The earlier you can start deferring your tax bill, the better! Plus, opening an RRSP earlier in life means the investments you hold in it have the greatest amount of time possible to grow. This reduces pressure to perform that might otherwise be created by starting later in life.

You can open an RRSP through any financial institution, like a bank, insurance company or credit union. At this point, you can choose to have a self-directed RRSP (in which you pick and control all the investments that you hold in it), your financial advisor can help you or the issuing financial institution will assign you someone to help select investments based on your goals.

You can hold a number of currencies, such as cash, stocks, bonds, and other securities in an RRSP. Though some people chose to operate their RRSP in a self-directed manner, a financial advisor will help you determine which investments are best suited to go in your RRSP. If you don’t have a financial advisor, most financial institutions will offer you an account manager for your RRSP that can help.

Similar to an RRSP, you can also join a PRPP in Canada, which stands for a Pooled Registered Pension Plan. A PRPP is similar to an RRSP, but allows individuals (even self-employed individuals) the opportunity to save into a large, pooled pension plan, which can reduce the amount of administrative fees they may pay over time. PRPP’s are also portable, meaning they can move from job to job easily.

RRSP’s are unique because you don’t get taxed on the income you hold in them until you withdraw it. All the money and investments you save in an RRSP are allowed to compound and flourish completely tax-free as long as they reside there.

Because you aren’t taxed on income held in an RRSP until you withdraw it, you can also use an RRSP to strategically reduce your current day tax bill. For example, let’s say you’re set to earn $60,000 in 2021. If you contribute $8,000 to your RRSP before the end of the 2021 tax year, the government will tax you as if you earned $52,000 instead of $60,000.

However, once you go to withdraw from an RRSP, whatever you withdraw will be counted as taxable income in the year you withdraw it. This is a policy in place to encourage people to keep money and investments saved in their RRSP’s until they’re truly retired. When you retire, you’ll be taxed at a much lower rate than you are during your peak income-earning years. As such, withdrawing money from an RRSP when you’re actually retired means you’re going to pay the lowest possible tax rate on that income.

On the other hand, if you withdraw money from your RRSP before you’re actually retired, you’ll have to report that money as earned income for tax purposes in the year you take it out. You may only need a bit of money to cover the gap during a tight week, but that move may actually bump you to a higher income tax bracket for that year. In this way, having an RRSP is not an ideal way to help manage your short-term financial needs.

As a registered account, RRSP’s come with their own annual contribution limits. As a refresher, the annual contribution limit for any registered account is the maximum amount of money an account holder can legally contribute to that type of registered account each year. Annual contribution limits are enforced with registered accounts as a way to equalize the playing field across income levels and put a cap on the level of preferential tax treatment available.

The annual contribution limit for a Canadian RRSP is whichever is the smaller figure of either 18% of your past year’s annual income or the annual maximum for that year. Like with TFSA’s, there is an annual maximum limit as selected by the government that increases slightly each year. However, the annual contribution limit for RRSP’s is much more personal, and harder to calculate on your own as a result. The annual maximum limit for 2021 is $27,830.

You can find your annual RRSP contribution limit on your Notice of Assessment you would have received from the CRA when you filed taxes in 2020. Your true contribution limit may be higher than the annual contribution limit if you have not made up your contribution limits in previous years. As calculating the annual contribution limit for RRSP’s is a bit more complicated than it is for TFSA’s, this is best way to definitively confirm your contribution limit for 2021.

You can withdraw from most RRSP’s at any time, but will face penalties for doing so. This is again an incentive for Canadians to keep their money saved in their RRSP’s until they’re actually retired. Let’s imagine you’re middle-aged today and you need a few thousand dollars to cover an emergency car repair. You don’t have access to that money in a liquid form elsewhere right now, so you need to turn to your RRSP. First, the amount you withdraw today will be added to your 2021 tax bill as earned income. So, let’s say you withdraw $4000 – that will increase your annual income that year in the government’s eyes, and therefore your tax bracket, by $4000. Next, you’ll be charged a withholding tax on that money. The rate will be dependent on the total amount you withdraw, but will be between 10% and 30%. Finally, you’ll permanently lose the equivalent amount of contribution room in your RRSP as your withdrawal. That means, you don’t get the chance to make up what you’ve withdrawn at a later point in time.

It should be noted that some RRSP’s are locked in, meaning account holders cannot make any withdrawals until they reach a certain age. If you’re unsure about your RRSP, you’ll need to contact your account provider directly to confirm.

You can set up a spousal or common-law partner RRSP with a long-term partner to help balance tax responsibilities between the two of you as effectively as possible. A joint RRSP is the most advantageous when one partner earns more income than the other. When the higher-earning partner makes the maximum contribution to the RRSP, it minimizes their present day tax bill. Then, when it comes time to withdraw from the RRSP, the lower-earning partner does so and reports it as income, as they’ll be in a lower tax bracket than the other partner. 

TFSA’s and RRSP’s are similar, but are not the same. They can be used in a complimentary manner to minimize your tax bill throughout the course of your life. Both TFSA’s and RRSP’s are registered accounts that are designed to encourage Canadians to grow their savings. However, there are some important differences between the two that differentiate how you should be using them.

• As you’ve already paid tax on that money, you can withdraw savings from a TFSA at any time without paying any additional taxes or fees to do so. You also won’t permanently lose your contribution room as you do when you withdraw from a RRSP. As such, a TFSA is better for managing your short-term needs than an RRSP is.

• A TFSA won’t help you minimize your current tax bill in any way. Everything you put into a TFSA has already been taxed based on your income level in the year you earned it. Saving in an RRSP can help you reduce your tax burden by pushing you into a lower tax bracket than you are otherwise.

If you want to learn more about TFSA’s, check out TFSA’s: Everything You Need to Know.

If you over-contribute to your RRSP, the CRA will charge you a 1% fee each month on the total amount exceeding your true limit. You’ll be likely to receive a warning from them asking you to move that excess money to another account.

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