RRSPs: What to know about saving for retirement in CanadaIllustration by Melanie Lambrick
Saving for a happy, comfortable retirement is one of the most common goals of personal financial planning for Canadians. A clear understanding of how a RRSP (Registered Retirement Savings Plan) works, tips for picking the savings plan that works for you, and some common terms will help relieve the strain and set you up for success in your golden years. Here’s a primer on the basics of a registered retirement saving plan, along with insights from personal finance experts.
What is an RRSP and how do they work?
An RRSP – short for registered retirement savings plan – is, as the name suggests, a savings plan for retirement. RRSPs are tax-advantaged accounts, meaning they provide a tax break.
The program was introduced in 1965 to help Canadians save for their retirement. The key benefit of an RRSP is that tax is deferred until retirement.
All contributions are tax-advantaged, meaning they won’t be taxed until you withdraw the funds. The same goes for investment income made from investment in the RRSP: It can grow tax-deferred until it’s withdrawn.
The plan lasts until the end of the calendar year when you turn 71, at which time it must be converted into a registered retirement income fund (RRIF).
What are the benefits of opening an RRSP?
An RRSP is one of the few ways Canadians can earn an income-tax reduction during their earning years, as the amount contributed to an RRSP is tax deductible. You pay income tax on RRSP money when it is withdrawn, ideally in retirement when you will likely be in a lower tax bracket. This tax deferment is one of the key benefits of the savings plan.
Note that you don’t have to claim the deduction in the year you contribute. It’s possible to defer the deduction to a future year. This might be a good choice for you if you have money to invest now, but expect to have a higher taxable income in future years.
In addition, any earnings within your RRSP account, such as interest or dividends, remain inside the account and are not taxable until you make a withdrawal.
Here’s how to build a successful RRSP
Another advantage is that many workplaces have automatic contribution plans set up for employees’ RRSPs. This means that your payroll department will transfer your contributions directly into your RRSP, making it easier to save. Some companies also offer RRSP matching, through which they will contribute additional money beyond what employees themselves are saving.
For maximum benefit, open the account as early as you can and be sure to create an automatic contribution plan – something that deposits a set figure to the RRSP each month or each paycheque. Your employer or bank can do this.
How do you open an RRSP?
To open an RRSP, you need to be under 71 years old, but there is no minimum age requirement. (The earlier you start investing, the better.) You will need a social insurance number. Minors can open an RRSP with a letter of consent from a parent or legal guardian, who will retain signing authority until the child turns 18.
You must also be a Canadian resident for tax purposes, file income taxes in Canada and have an income. Opening an RRSP can be done at any financial institution (a bank, credit union, trust or insurance company), including online. While you can open as many accounts as you wish, the contribution limit doesn’t change.
What kinds of investments can be held in an RRSP?
Stocks, bonds, mutual funds, exchange-traded funds (ETFs), segregated funds, cash deposits and guaranteed investment certificates are among the broad range of investments allowed in an RRSP. And there are no limits on foreign assets.
How to pick an RRSP
An important thing to keep in mind is that an RRSP isn’t an investment per se – it’s a sort of container that holds an investment or set of investments. With that in mind, when setting up an account, says columnist Gordon Pape, it’s a good idea to opt for maximum flexibility. Find out exactly what the plan is allowed to hold, and what is excluded.
For example, your local bank may offer a plan that allows you to invest in their mutual funds but not those of other financial institutions. A brokerage account with an online company will usually provide the best combination of flexibility and minimal costs.
Once you’ve set up an account, the next step is to choose what to invest your money in and how much to deposit. As with any investment, the choices that are right for you will depend on your age, risk tolerance and personal preferences, such as how hands-on you want to be managing your portfolio and whether options such as sustainable investing are important to you.
If you’re not going to need your investment for at least five to 10 years, columnist Rob Carrick says that one option is to put your money in an asset-allocation fund, a.k.a. a balanced ETF. These all-in-one funds are designed to give you a balanced portfolio in a single package of bond and stock market ETFs. Another way to get similar results, he says, is through a robo-adviser, which will offer more support and guidance (as well as slightly higher costs).
What is the annual contribution limit and the 2023 deadline?
The Canada Revenue Agency (CRA) imposes an annual limit on how much you can deposit into your RRSP account. The limit is calculated as a percentage of your previous year’s income, up to a maximum amount that is set by the government each year. If you do not contribute the maximum allowable to you in a certain year, the remainder is carried forward to the following year.
Your personal RRSP contribution limit can be found on the notice of assessment you receive from the CRA after your annual income taxes have been processed. You can also find it by logging into your CRA account.
Find the current and historical limits for RRSP contributions on the Canada Revenue Agency website.
Six tips from Tim Cestnick for RRSP season
Keep in mind that while there is often talk of “RRSP season” every February leading up to the annual contribution deadline, investment adviser Rory Tufford recommends setting up regular automated contributions throughout the year rather than a lump sum right before the deadline. And if you do end up making a last-minute contribution, remember that you don’t necessarily have to invest the money to make it count for your taxes, so long as the cash has been moved into your RRSP account on time.
Note that the RRSP contribution year does not correspond to a calendar year. Instead, it runs from March 2 to March 1 of the following year. For instance, any funds deposited into your RRSP between March 2, 2023 and March 1, 2024 correspond to the 2023 tax year. (Note that these dates are subject to change; it’s a good idea to double-check on the CRA’s website.)
The maximum RRSP contribution limit for 2023 is 18 per cent of your previous year’s earned income or $30,780 – whichever is less. The next RRSP contribution deadline is March 1, 2024.
What happens if you contribute over the annual RRSP limit?
While it’s important to stay organized when calculating your RRSP contributions, it’s easy to make errors. With this spirit in mind, if you do contribute more than the annual limit, the CRA will forgive the first $2,000 of your overcontribution. In other words, if your annual limit is $10,000 and you contribute up to $12,000, you won’t receive a penalty.
All contributions above that, however, will be subject to a 1 per cent tax for every month you’re over the limit. (The CRA will likely send you a notice if and when you overcontribute, encouraging you to move that money.) Late payment of this tax can result in interest fees and other penalties.
The exception is if you withdrew the excess contribution or contributed to a qualifying group plan. You can also apply to have the tax waived or cancelled under certain conditions, such as a reasonable error. If you have made an overcontribution, it’s best to deal with it quickly following the guidelines laid out by the CRA.
How does the money in an RRSP grow?
There are two ways the money in your RRSP will grow. One is by continuing to make deposits into the account. The other is by earning money on your investments. How the latter works depends on the content of your RRSP; e.g., whether it’s stocks, bonds, GICs or other types of investment.
Can you lose money in an RRSP?
Yes, you can lose money in an RRSP. Whether this actually happens depends on the types of investments you hold and the timing of your withdrawals.
Some investments are riskier than others, and this is no different within an RRSP than outside one. (In fact, you might be better off holding riskier investments outside your RRSP, as at least the losses will be tax deductible.)
Jason Pereira, a financial planner at Woodgate Financial Inc. in Toronto, points out that the biggest danger isn’t losing money on paper, but losing money and then cashing out. This is where age and timing come in. Younger investors have more time to ride out market lows.
It’s a good idea to have a diversified mix of stocks and bonds whose historical risk level is in line with your risk tolerance, Mr. Pereira says.
Is a TFSA better than an RRSP?
Neither is better in itself – it’s just a question of which is better for you, right now.
The main difference between a TFSA and an RRSP is when you pay the income tax.
RRSP contributions will reduce your tax bill when you put the money into the account, but you will be taxed when you make withdrawals. You can also contribute more per year to an RRSP than a TFSA (tax-free savings account), and because the money is taxed when it is withdrawn from the account, you might have more incentive to leave it alone.
TFSA contributions won’t reduce your tax bill when you put the money in, but you won’t be taxed on the contribution amount or on any gains when the money is withdrawn, and in general, you can withdraw from your TFSA account easily. (Though keep in mind that any withdrawals can only be replaced in the following calendar year – you can’t treat your TFSA account like any savings account. Review the CRA guidelines before making withdrawals and contributions.)
Should you start an RRSP at 70?
With this in mind, choosing between a TFSA or RRSP depends on a number of factors including your age, debt levels, financial goals, current income, tax rate, expected retirement income and more.
For instance, higher-income earners tend to get a greater benefit from RRSP contributions, says Rob Carrick, whereas “younger people who aren’t yet in their peak earning years will likely get the best after-tax result from a TFSA.” Ted Rechtshaffen, president and chief executive officer of TriDelta Financial in Toronto, recommends that clients who make less than $45,000 a year save in a TFSA first and those who make more than $85,000 prioritize the RRSP.
Both are effective tools for saving – and contributing to both will provide flexibility when making withdrawals – but if you can only fund one account, let your real life-scenarios inform your decision.
How do you withdraw from an RRSP without paying tax?
You can withdraw funds from your RRSP at any time, not just once you’re retired. But in most cases, those funds are taxable.
There are some situations when it makes sense to make an early withdrawal from your RRSP – like pulling cash out to take advantage of the Home Buyers’ Plan (HBP) or the Lifelong Learning Plan (LLP) – or to minimize a tax hit.
- What is the HBP? The HBP allows you to withdraw up to $35,000 tax-free, to help make a down payment on a first home, or for those who haven’t owned a property within the past four years. Legally married or common-law couples can withdraw up to $35,000 each for a total of $70,000 toward the same home purchase. You then have 15 years to repay the borrowed amount back into your RRSP, with the first payment due two years after the withdrawal.
- What is the LLP? If you’re returning to full-time education or training, you can withdraw up to $10,000 tax-free from your RRSP. You have up to 10 years to repay your RRSP under the LLP.
If you fail to make the annual minimum repayment, it will be added to your income for the year and taxed, so there is a strong incentive to repay the funds.
Early RRSP withdrawals can have lasting consequences
As you begin your retirement, early withdrawals from an RRSP could minimize your overall lifetime tax hit. This is often the case where a person retires at age 65, or sooner.
For example, if you have a large RRSP, the amount you will be required to draw from your RRIF once you hit age 72 – a set percentage that increases each year – could put you in a bracket where you are paying a substantial amount of tax. However, if some of that RRSP is withdrawn between ages 65 and 71, the tax rate may be significantly lower.
How do refunds on RRSPs work?
When you make RRSP contributions, you can use the amount to reduce your tax payable. If you do this when you’re filing your taxes and the CRA concludes you overpaid income tax for that year, you will receive a refund.
How this works specifically depends on your situation. For instance, if your RRSP contributions are being made through your payroll department, they may already be reducing the amount of income tax they deduct from your paycheques, in which case you may not receive a refund with your notice of assessment.
The total amount of the tax reduction you receive thanks to RRSP contributions depends on your taxable income and the amount you have contributed.
RRSP deductions don’t have to be claimed in the year you made the contribution – they can be carried forward instead. This might be the right choice for you if your income is relatively low and you expect to have higher income in future years. For instance, students – many of whom don’t pay tax at all – should either avoid RRSPs (and invest in a TFSA instead) or carry forward their deductions to avoid wasting them, says Camillo Lento, assistant professor of accounting at Lakehead University.
RRSP terms and definitions
What is an individual RRSP? As the name suggests, an individual RRSP is a plan that belongs to one person.
What is a self-directed RRSP? You are managing the money and assets in the plan yourself, likely through an online platform.
What is a group RRSP? A group RRSP and an individual RRSP are virtually the same – the only difference is that in a group plan, it’s set up by your employer and contributions are made directly by payroll deductions. Often, but not always, a group RRSP will come with a matching contribution from the employer. Annual fees on the funds in the plan are relatively low and the investment options will vary from employer to employer. If you leave your employer, the contributions can be moved to an individual RRSP, used to purchase an annuity or taken in cash (and taxed that year).
What is a spousal RRSP? The spousal RRSP enables higher-income-earning spouses to put retirement money away for a lower-income spouse. The higher-earning partner contributes to the spouse’s RRSP, and later, when that spouse withdraws income – as long as certain waiting-period rules are met – that cash is attributable to the lower-earning spouse, who is likely in a lower tax bracket. Keep in mind that contributions to spousal RRSPs are counted as part of the contributing spouse’s annual limit.
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