What is an RRSP?
A registered retirement savings plan (RRSP) is essentially a type of investment account that the Canadian government has created to encourage the idea of saving for retirement to Canadians. RRSPs can hold a variety of investments, including mutual funds, bonds, treasury bills, and many more. The main advantage of an RRSP account compared to a regular investment account are the tax benefits that come with it. The contributions made to an RRSP (up to a certain limit) are tax free and the money within an RRSP can compound without you having to pay taxes on the gains.
There are two forms of tax benefits that come with contributing to an RRSP:
- Tax Deferred Growth
All investments within an RRSP grow tax deferred, which means any profits made on investments within an RRSP account are not immediately taxable to you as income. RRSP investors do have to pay taxes on the profits in their RRSPs, but this doesn’t happen until the funds are withdrawn. Tax deferred is still a benefit, because in theory, income tends to be lower in retirement than in your peak earning years.
- Tax Credits
Your taxable income is reduced by the amount you contribute – up to a certain point.
When contributing to your RRSP, the maximum you are allowed to put in each year is the lower of $26,230 (2018) or 18% of earned income. By contributing to your RRSP, you reduce the amount your income is taxable, as what you put into your RRSP isn’t taxed until you withdraw.
Why open an RRSP?
The tax benefits are significant enough to make a large difference when comparing an RRSP to other kinds of accounts. By not taxing Canadians on the funds they contribute to their RRSPs, the government rewards those who save up for retirement. Tax-free growth is one of the biggest advantages of RRSP contributions. In an RRSP, the money that would have been spent on taxes is basically invested back into the portfolio, rather than being taken out of the portfolio and given to the government, reducing the amount of income tax you must pay each year and allowing your investments to compound tax-free.
How Can I Contribute To My RRSP?
You are allowed to contribute up to 18% of your previous year’s earned income to the maximum amount set each year by the Income Tax Act and Regulations, along with any unused contribution room carried forward from previous years. Contribution room is the difference of how much you contribute to your RRSP and the maximum you can contribute. Your contribution room can carry forward from previous years too. For example, if one year your maximum allowed contribution is $10,000 and you only invest $5,000, next year you’re allowed to add the $5,000 you missed to your maximum allowed contribution for the next year or in any year until you turn 69.
If you have contribution room, you can contribute at any time – either in a lump sum or by making periodic contributions throughout the year. Having a regular savings schedule is the key to a healthy RRSP – the longer your RRSP contributions are invested, the longer they will have to grow.
There are a number of ways to withdraw money from your RRSP, but be careful: some withdrawal methods are significantly more expensive than others.
The original purpose for RRSPs is so that Canadians can save money for retirement. The government has now expanded the program to allow saving for home purchases and education, but they still don’t want people using them to save for vacations and fancy cars. If you have an RRSP and want to take money out for anything other than retirement, post-secondary expenses, or the purchase of a home, you’ll be faced with the grueling pain of withholding taxes:
if you take out $0 – $5,000, you have to pay withholding tax of :
- Quebec: 21%
- All other provinces: 10%
$5,001 to $15,000:
- Quebec: 26%
- All other provinces: 20%
- Quebec: 31%
- All other provinces: 30%
As well, the amounts that you withdraw in any year will have to be reported on your tax return for the year of withdrawal.
Not only do you get punished with withholding taxes, but you’ll also never be able to recontribute the amount you take out of your RRSP through an early withdrawal. For example, if your lifetime contributions to your RRSP thus far total $10,000 and you have not always made the maximum allowable contribution, you have also accumulated $20,000 in additional contribution room. If you withdraw the $10,000 and want to re-contribute that at a later date, the recontribution will reduce your total room of $20,000 down to $10,000.
RRSP Home Buyer’s Plan
The RRSP Home Buyer’s Plan (HBP) allows you to borrow money from your RRSP to support the purchase of a house without being hit with withholding taxes. The maximum amount you can borrow from your RRSP with the HBP is limited to $25,000. You also can’t have owned a house in the last five years. For those that choose this option, a 15-year period is given to pay back the money borrowed from their RRSPs. However, once 15 years has passed, the opportunity to replace the borrowed money is forever lost.
There are significant benefits to using the HBP compared to borrowing from the bank to buy a home. There is a huge amount of interest that must be paid on a mortgage – borrowing from your savings allows you to avoid or reduce mortgage insurance and build the equity in your home faster.
RRSP Lifelong Learning Plan
The Lifelong Learning Plan (LLP) allows you to borrow money from your RRSP to go to school. The maximum amount of money you’re allowed to take out is a little less than with the HBP – $20,000, and only $10,000 can be withdrawn each year. Repaying an RRSP withdrawal from the LLP doesn’t have to start until five years after the first withdrawal. Once your repayments begin, you have ten years to pay the money back to your RRSP before you lose the opportunity to replace these funds.
How Do I Get My Money Now That I’m Retired?
Once you’ve retired, all you have to do to get your saved-up money is go to the bank that is holding your RRSP account and say that you have retired. Your RRSP will then be transferred to a Registered Retirement Income Fund (RRIF) account, which then pays you! Your carrier calculates the minimum amount to be paid to you based on your age at the beginning of each year based on a general formula that considers your current age. By withdrawing the minimum amount, you pay less income taxes than you’ll pay on the withdrawals, so if you withdraw as little as possible in the early years of your RRIF, your savings will last longer because more of your money will stay in the RRIF and continue to grow tax free.
With that being said, there is no maximum withdrawal limit, but all withdrawals are fully taxable. If you take out more than the minimum amount, you’ll also be paying the same withholding tax rate for the same amounts that applied for when you hadn’t retired yet, but now its how much you withdraw in excess of the minimum amount.