Your Guide to RRSP Accounts in Canada
Following economic devastation, as governments shut down nations due to COVID-19, it is more important than ever to plan your future carefully. Thankfully, the Canadian government of 1957 had enough foresight to implement a robust retirement system in the form of RRSP.
This retirement policy served Canadians well for over half a century and will continue to do so in the future. Here is all you need to know about RRSP and how to manage it for the most significant effect on your financial security.
What is an RRSP?
Short for Registered Retirement Savings Plan, RRSP was designed by the Canadian government to regulate investment accounts that have special tax status. Therefore, any RRSP contribution is tax-deferred up until the time the money is withdrawn from the account.
Such a beneficial tax status provides incentives for people to put some of their money away for retirement. However, that is only the beginning of the benefits, considering that an RRSP account can hold many types of contributions, such as GIC, cash, mutual funds, stocks, exchange traded funds (ETFs), bonds, and precious metals.
How does an RRSP work?
Whenever you make a deposit into your RRSP account, which is registered and regulated by the federal government, that deposit is exempt from the CRA (Canadian Revenue Agency) taxation in the year the deposit had been made.
Afterwards, when you are ready to retire and withdraw the money, CRA will tax it. Suffice to say, RRSP is an excellent method of cutting down your annual tax bill. This is why RRSP is called a tax-deferred investment account.
Main Benefits of Opening an RRSP
The moment you contribute to your RRSP account, you receive tax relief from your income for that fiscal year. In other words, these are tax-deductible contributions as if taxation doesn’t exist. Furthermore, you can generate earnings from your assets in the account because RRSP investments are also not taxed as long as they are not withdrawn.
Lastly, taxation occurs on your contributions and your investment earnings only if you pull the plan’s assets. This means that your future tax could be lower than the tax rate in the year you made your RRSP contributions.
How to Choose the Right RRSP
People often ask that question without realizing it is the wrong one. Instead, one should ask — what to put in an RRSP? After all, an RRSP is simply a plan/account that allows you to invest in many different securities, as long as the CRA approves them.
Therefore, based on your goals, you can choose to set up your RRSP in four significant ways:
- As a GIC plan — The Guaranteed Investment Certificate is a way of locking your money for a period of time, usually five years, in exchange for the guarantee of a full principal return upon maturation, plus the interest rate. This money is CDIC-insured by up to $100,000. The interest rates are in flux, but you would do well to look at smaller banks and credit unions for the highest returns within five-year rates. Above 2.2% is considered to be higher interest rates in the current economic environment.
- As a savings plan — The most straightforward plan, serving as a bank account protected from taxation. For example, Alterna Bank offers its RRSP eSavings account at a 1.4% interest rate. As you may immediately notice, this is lower than even the medium GICs. Of course, just like GICs, savings accounts are CDIC-insured if the bank is a member.
- As a self-managed plan, this approach to your RRSP allows you the highest degree of flexibility and a risk. You can invest in GICs as well as bonds, stocks, ETFs, mutual funds, income trusts, equities, gold, silver, T-bills, and cash. However, if you rely on the stock market activities to increase your funds, the risk is rather high. You will be operating outside the boundaries of deposit insurance coverage. Accordingly, if you opt to follow the self-managed path, it would be prudent to select a brokerage company to do it for you.
- As a mutual fund plan — Once you pick the bank or credit union for your RRSP, you will have the option to invest in these financial institutions’ mutual funds. Diversification of funds is critical to lessen the risks. Some mutual fund plans will focus on a specific brand instead of third-party options. If available, it would be ideal to buy no-commission mutual funds. Otherwise, negotiation is in order with your advisor to waive the fee for mutual funds with commissions when purchased.
What is the RRSP contribution limit?
The Canadian government has deemed fit to restrict the RRSP contribution per year basis. This contribution limit is particular to your own account, by balancing between any unused contributions of the previous years and this year’s deduction limit. However, deduction limits cannot accumulate.
You can easily check how much you can contribute by viewing the Notice of Assessment, following your tax filing for the previous year. Note that you must report your RRSP contributions on line 208 of your T1 General Income Tax Return.
What is an RRSP deadline?
The deadline for contributing to your RRSP is available on CRA’s official website here. Regarding the deadline when you no longer can contribute to your RRSP, it is December 31 during the year you turn 71.
When can you withdraw from RRSP?
If you withdraw before you turn 71, it will count as taxable income. Additionally, you will permanently lose the contribution space used to make the deposit, and you will have to pay a withholding tax.
Otherwise, on December 31 of your 71st birthday, you can no longer make any contributions, and your RRSP transforms into a Registered Retirement Income Fund (RRIF).
How much RRSP should I contribute to avoid paying taxes?
About 18% of your income, which is the limit of your annual income to make the contributions.
Can I take money out of my RRSP without penalty?
No, except in two scenarios:
- If you use the RRSP fund to withdraw up to $25,000 for the Home Buyer’s Plan.
- If you use the RRSP fund to withdraw up to $20,000 for the Lifelong Learning Plan.