So you ‘bought’ some RRSPs?
Or maybe you transferred some money into a TFSA?
Investment accounts can be challenging to understand.
And now you’re wondering… what did I buy? Was it right for me?
Was it an RSP? An RRSP? What’s an RSP vs. an RRSP anyways?
By the time you’re done reading this guide, you’ll understand the difference between the accounts and hopefully leave your next advisor appointment with more answers than questions.
What is an RSP?
RSP stands for Retirement Savings Plan.
An RSP is typically a tax-advantaged account that offers Canadians a way to make the most of the money they’re socking away for retirement.
RSPs can include:
- Any other retirement savings strategy
Different Types of RSPs
Of the registered types of RSP’s, your options consist of the RRSP, TFSA and if you are lucky enough to work for an employer who offers one, the RPP.
1. RRSP: The Popular Choice
RRSPs, or Registered Retirement Savings Plans, are what most people refer to when discussing retirement savings plans.
Despite the popularity of RRSPs, there is still some confusion about them.
An RRSP is an account you can hold your retirement savings in, where they can grow tax-free until you choose to withdraw from it.
Any contributions you make are tax-deductible, so you get a tax break for the year of your contributions.
You only pay taxes when you withdraw the money.
This is referred to as tax-deferral (postponing payable tax).
Sounds great, right?
Why not just place all your savings into an RRSP?
Well, first off, you can’t.
There’s a limit to how much you can contribute to an RRSP.
It’s the lesser of either: 18% of your previous year’s earned income OR the government prescribed annual limit (last year was $27,230).
Also, in a way, you essentially lock your money into your RRSP when you contribute.
That’s not to say you can’t take your money out, but doing so comes with hefty tax penalties and loss of contribution room.
You have to wait for your retirement before you can start withdrawing from your RRSP.
RRSPs have two main benefits: tax deferral and tax-sheltered growth.
Secondary benefits include the HBP, the LLP, and locking in savings (for those who need encouragement to stay invested).
Did You Know?
The RRSP has been around since 1957.
2. TFSA: Young And Full of Potential
TFSAs (Tax-Free Savings Accounts) are relatively new compared to RRSPs, but that doesn’t exclude them from confusion.
You would be correct to think they are just a new type of savings account according to their name.
That is true, but they also have unique “tax-free” qualities.
Like the RRSP, your savings can grow tax-sheltered for years and compound into a sizable portfolio.
The difference, though, is that you make TFSA contributions with net dollars.
Meaning you’ve already paid income tax on the money you’re putting into the account.
Why does this matter?
Since the government already has their share of your money, they’re nice enough to let the gains from your investments be completely exempt from tax.
As a result, you could potentially grow a large sum of tax-free income depending on how and when you invest.
As with the RRSP, how much you can contribute is limited, typically much less than RRSPs.
The current total contribution room is $75,500, and each year $5,000-$6,000 of contribution room is added.
Sounding like the shiny new TFSA may be the best option for your retirement savings, right?
Not so fast.
Remember, you are contributing with after-tax dollars.
Meaning you won’t be getting a tax break that year when you make contributions.
The other thing is there aren’t any tax penalties when withdrawing from your TFSA.
While that is the main benefit, there are fewer immediate consequences to pulling money out of your investments.
As a result, you could cause yourself to have less money in retirement by missing out on the effects of compound growth.
In other words, if you lack discipline, a TFSA won’t help keep your money invested like an RRSP could.
A TFSA contribution is made with after-tax dollars – you won’t get a tax rebate by adding to your TFSA.
3. Registered Pensions Plans (RPP)
One RSP you don’t need any discipline for is a Registered Pension Plan (RPP).
That’s because these types of RSPs are employer-controlled, and for the most part, you don’t get to withdraw from them until you’re retired anyways.
There are two types of RPPs: the Defined Contribution Pension Plan (DCPP) and the rarer one, the Defined Benefit Pension Plan (DBPP).
Both of these plans are employer-sponsored, so you can’t sign up for one yourself like you can with an RRSP or TFSA.
If you are fortunate enough to work for an employer that offers either of these plans, make sure you get signed up for it as early as possible to take advantage of employer contributions and early compounding for your investments.
RPPs are employer-sponsored – you can’t register for one unless your employer offers it.
i. Defined Contribution Pension Plan (DCPP)
The DCPP is pretty much an RRSP with less control.
You make tax-deductible contributions, which grow tax-free until you retire, at which point your withdrawals get taxed at your marginal tax rate.
The difference between a DCPP and an RRSP is that in a DCPP, you can’t participate in the HBP or LLP.
You also can’t withdraw even if you’re willing to accept the tax penalties that you’d have with an RRSP withdrawal.
The good part about a DCPP is your employer is often matching your contributions (or at least contributing as well) to your pension plan.
This contribution matching in itself would make a DCPP more worthwhile than a typical RRSP.
ii. Defined Benefit Pension Plan (DBPP)
A DBPP is like a golden RSP, because there aren’t as many around these days.
Like the DCPP, you make tax-deductible contributions to your pension plan, which is locked in until you retire.
Also, your withdrawals (or payments) get taxed at your marginal tax rate, just like the DCPP.
However, unlike the DCPP, RRSP and TFSA, your retirement portfolio and the amount you can withdraw isn’t dependant on how well your investments do.
No, with a DBPP, you are entitled to a set payment amount every year for your entire retirement.
You don’t have to worry about contribution room, choosing suitable investments, or even outliving your savings; all that is taken care of for you.
You just need to work for an employer that offers this pension plan long enough to qualify for the maximum payout.
Registered vs Non-Registered Accounts
Everything mentioned so far has been in the world of registered accounts.
These accounts all have several benefits but also have their limitations.
You have to pay for the tax savings by satisfying contribution rules or giving up some control over your money.
Although these benefits are well worth the cost, an alternative RSP gives you complete control over how and when you invest or withdraw your money.
While the banks don’t advertise it as an RSP, you can use a Non-Registered Account to invest or save for retirement.
The rules are more straightforward.
You can contribute and withdraw as much and as often as you’d like.
The only downside is you don’t get any tax exemptions on your earnings.
There are, however, many strategies and products out there that can help reduce your tax bill in a non-registered account.
So, if you want complete freedom over your retirement savings or you manage to max out your registered accounts and want to invest some more, opt for a non-registered account to park your dollars.
You are in full control of your deposits and withdrawals in a Non-Registered Account.
Now that you know the difference between an RSP vs RRSP, you’ll no longer be confused when talking about retirement savings plans.
And, armed with the knowledge in this guide, you can now determine which type of account makes the most sense (or dollars) for your next retirement savings contribution.
Frequently Asked Questions
- Are an RSP and RRSP the same thing?
No. An RSP is any Retirement Savings Plan whereas an RRSP is a particular registered account with specific rules, benefits and limitations.
- Is an RSP a good idea?
An RSP is usually a good idea. If you can save some of your own money for retirement, it makes sense to take advantage of the registered accounts and the tax savings they offer. Saving for retirement is one of the most important aspects of a personal financial plan – the earlier you understand how to save and invest for your retirement, the better.