A RRSP – Registered Retirement Savings Plan is an account registered with the federal government to save for retirement. Created in 1957 as part of the Canadian Income Tax Act, this kind of account helps Canadians save for retirement through tax obliterating.
Also called tax-advantaged accounts, they were created specifically to provide tax breaks to investors, as a way to motivate them to put away money for retirement.
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A great way to save
Contributing to an RRSP gives you a deduction when you file your taxes, which means that your taxable income is reduced. In addition, your money grows tax-free, meaning that all capital gains and dividends won’t be taxed, as long as the money remains in the RRSP.
Although their primary purpose is to save for retirement, you can also use it to help with the down payment to buy your first home through the Home Buyers’ Plan or to fund your education through the Life Long Learning Plan.
Tax-deferred doesn’t mean tax-free
Contributions and investment gains in a RRSP are not tax-free. You’ll pay tax on the money when you withdraw it at retirement. However, the income you earn is sheltered from taxes, allowing it to grow faster. Presumably, by the time you retire, you’ll be in a lower tax bracket and will end up paying less. What happens is that investors delay the payment of taxes until retirement when their tax rate will be lower than during the working period.
RRSPs are registered accounts
As they are registered accounts, RRSPs are subject to certain rules. The most important one concerns the amount of money you can contribute to your account every year. This amount may be 18% of your past year’s income or a maximum amount stipulated by the government, whichever is smaller. For example, the number for 2019 was $26,500 and for 2020 will be $27,230.
However, you can carry forward your unused RRSP contribution from years of lower-income and use it in future years when your income may be higher. This can help you benefit from tax savings when you are in a higher tax bracket.
Approved and prohibited assets
Qualified investments such as cash, savings accounts, GICs (Guaranteed Investment Certificates), mutual funds and ETFs, government and corporate bonds, equities both Canadian and foreign, gold and silver bars and more make up the wide variety of approved investments in RRSPs.
As such, the value of your RRSP may go down or up, depending on the investments it holds.
However, precious metals, personal property as art, antiques and gems, commodity futures contracts, investments in entities which you hold an interest of 10% or more, shares in private holding companies, foreign private companies and real estate are considered non-qualified investments and are prohibited.
Who should consider a RRSP?
Every year, Canadians with salaries or wages from a job who file a tax return may contribute money to an RRSP. These annual contributions can be used as a tax deduction, which reduces the amount of tax a person will pay on their income. Furthermore, all capital gains and dividends aren’t taxed as long as the money remains in the account.
RRSPs may remain open until the end of the calendar year when a person reaches the age of 71. At this point, they must be closed or converted into what is known as an RRIF – Registered Retirement Income Fund.
Types of RRSPs
Generally, RRSPs are set up by a single person, but there is the possibility of a so-called Spousal RRSP, where the spouse also contributes and can benefit from it too. The Individual RRSP is registered in your own name and only you can contribute.
A Group RRSP may be set up by an employer in the name of the employees through payroll deductions or by members of a professional organization. Typically group accounts charge lower fees than the individual plans and allow investors to benefit from tax deduction immediately.
Since 2011, small business employees and small business owners have the option of a Pooled RRSP.
If your funds are not in a locked-in plan, you can withdraw from it at any time. However, as these accounts are intended to save for retirement, making withdrawals may impact your tax bill. If you chose to withdraw before retirement, the amount you take out will be taxed immediately and such amount will be added to your income when filing your income tax.
As mentioned before, the only exceptions are when the funds will be used to buy your first house or to finance your education.
How to open a RRSP?
A RRSP may be opened at most financial institutions in Canada, like banks, trust and insurance companies, investment firms and credit unions.
Low fees, no minimum investment required, and the kind of investments they offer should be your main concerns. As safe as they are, RRSPs are not risk-free. The investments you purchase should be based on your risk tolerance and investment objectives.
Anytime is a good time to start investing for retirement as there is no minimum age required to open an RRSP. Some financial institutions, though, may require people to be the age of majority.
Advisors used to say the sooner you begin the better. Typically, younger people will have more time to experiment with riskier investments that can eventually bring better returns. In addition, investing early can help you take advantage of the compound interests that these tax-deferred retirement accounts offer. But the truth is that it is always time to start investing and the best time to start your retirement plan is today, regardless of your age.