An RRSP is a government-registered savings account designed to help individuals save money for their retirement.
First introduced in 1957 by the federal government, RRSPs are noteworthy for two unique features: (i) the returns earned from investments held in the account are tax-sheltered until the funds are withdrawn, and (ii) contributions made are tax-deductible.
How does an RRSP Work?
An RRSP functions much like a regular investment account and can hold a wide range of financial products.
These include stocks, mutual funds, exchange-traded funds, bonds, guaranteed investment certificates (GIC), and precious metals.
There are four types of RRSPs:
- Individual – An account that is registered by and belongs to a single individual. Generally, investments in an individual RRSP consist of mutual funds and exchange-traded funds – products managed by financial professionals.
- Spousal – An account registered in your spouse’s name but which you contribute to. As the contributor, you can claim the tax deduction while the funds in the account belong to your spouse.
- Group – A pooled account set up and administered by an employer for the benefit of their employees. Employees can contribute funds to the group RRSP via payroll deductions, typically matched by employer contributions.
- Self-directed – A self-directed RRSP account is one where you manage your investment portfolio rather than having professionals do so on your behalf.
You’re RRSP contribution limit each year is based on the lesser of:
- 18% of your previous year’s gross income
- The prescribed annual limit ($30,780 for the 2023 taxation year)
As noted previously, any gains you earn on your RRSP contributions are tax-sheltered until you withdraw the funds, and you can deduct these contributions on your tax return, which can reduce your tax burden and possibly net you a refund.
The deadline for RRSP contributions is usually March 1.
How do I contribute to an RRSP?
You can open an RRSP account with a bank or credit union.
Alternative financial institutions and brokers such as Wealthsimple and Questrade also offer RRSPs.
You can complete the application process by calling or visiting the branch or online through their website.
Once your account is up and running, you can then choose the types of investments you’d like to hold in your account (provided they’re eligible).
The final step is to set up your contribution schedule and amount.
Most financial institutions offer the following deposit frequencies: weekly, bi-weekly, monthly, quarterly, semi-annual, and annual.
Each financial institution will have its policy regarding minimum initial deposits, but most will allow you to start with $100 or less.
Minimum scheduled deposits can be as low as $25 per month and are automatically debited from your bank account.
An essential rule to remember regarding RRSP contributions is that you have until March 1 of the following year to make a deposit and designate it for the current year.
How do I withdraw from an RRSP?
Withdrawing funds from an RRSP is a breeze: you simply notify your financial institution of your intention to do so, either in person, by phone, or online.
By law, you must report any funds you withdraw from an RRSP account as part of your taxable income for the year.
In addition, you must pay a federal withholding tax, which varies based on the sum of the withdrawals for the year.
You can find these rates here.
You can defer paying taxes on your RRSP withdrawals by transferring your entire balance to a Registered Retirement Income Fund (RRIF).
This account functions like an RRSP in that you can invest in a variety of investment products.
However, you can’t make regular contributions, and you’re obligated to withdraw a minimum amount each year, which is taxable.
Pros of an RRSP
1. Your money grows tax-free
Accumulating enough money for retirement can be a daunting task, especially since a portion of investments gains are lost to taxes.
But you can bypass paying tax on your investment returns as long as the funds are held within an RRSP.
This feature allows you to generate more growth from your deposits over time.
2. Your contributions are tax-deductible
It’s only natural to want to minimize your tax liability – and one of the easiest ways to do so is to contribute to an RRSP account.
During tax season, you can apply your contributions against your taxable income, reducing your tax payable for the year.
You can also defer your deductions to future years, which might be more advantageous from a tax planning perspective.
For example, suppose you anticipate earning more income in the future.
In that case, RRSP deductions will provide more tax savings as you’re in a higher tax bracket.
3. You can borrow from your RRSP to finance certain large expenditures
You can access funds from your RRSP to fund a home purchase under the Home Buyer’s Plan (HBP) or fund your education under the Lifelong Learning Plan (LLP).
These two programs allow you to “borrow” money from your RRSP account, which you must redeposit in future years.
But since the funds belong to you, it’s an interest-free loan you make to yourself.
Withdrawing RRSP funds under these two programs won’t trigger any tax penalties.
Cons of an RRSP
1. You’re taxed heavily for early withdrawals
Unless you transfer your funds to a RRIF, you must include any RRSP withdrawals in your taxable income and pay a withholding tax, as well.
Depending on your tax bracket, you could wind up with a sizable tax bill at the end of the year.
2. You won’t realize many benefits if you’re a low-income earner
The tax savings associated with RRSP aren’t democratic – they’re typically only realized by those earning a substantial income.
Suppose your income level places you in the lowest tax bracket.
In that case, your tax liability is already minimal or non-existent, to begin with.
Thus, deducting RRSP contributions won’t yield any further savings.
3. Withdrawals could negatively impact other government income sources
You must include RRSP withdrawals as part of your taxable income when your file your tax return.
Unfortunately, this may affect your eligibility for government-sponsored benefit programs like Old Age Security (OAS) and Guaranteed Income Supplement (GIS).
The amount you can expect to receive from such programs depends heavily on your total income for the year.
Once your income exceeds certain thresholds, your benefits are clawed back.
