RRSP [Registered Retirement Savings Plan]

rrsp winnipeg

How Does an RRSP Work?

RRSP or Registered Retirement Savings Plan is a retirement saving and investment account that is registered with the Canadian government and the CRA (Canada Revenue Agency).

The RRSP program was created as part of the Canadian Income Tax Act of 1957 to encourage Canadians to save for retirement.

Basically, a Registered Retirement Savings Plan is a retirement saving and investing medium for all Canadian income earners, whether you are an employee, self-employed or a business owner and there is no age restriction to opening an RRSP account.

Anyone who has earned an income is eligible to open and start contributing to their RRSPs. This is similar to 401K in the US with some key differences.

One of the key benefits that you are entitled to enjoy when you or your spouse contribute to your RRSPs is that your contributions can be used to reduce your taxable income each year you contribute into this tax-sheltered account; in effect, your deductible contributions reduce your income tax.

The second and real benefit of an RRSP account is the tax-free growth of your funds inside the account, which can grow either in interest, or market returns. Your contributions plus any gains remain tax-free up until withdrawal.

rrsp winnipeg

Types of RRSP

There are three general types of RRSPs:

  • Individual
  • Spousal
  • Group

Individual RRSP

An individual can set up his or her own RRSP by opening an Individual RRSP account with the account holder and the contributor being the same person.

Spousal RRSP

A spousal RRSP is technically an individual plan, where the higher income spouse or common-law partner contributes to the lower income partner’s RRSP account and use the deductible RRSP contributions to lower his or her taxes at the year of contribution.

Group RRSP

In a group RRSP, employers can reward their employees by helping them save toward their retirement through employer RRSP contributions.

Group RRSPs are first set up by the employers for their employees. The contributions are usually made up by both employee and employer contribution with tax benefits credited to the individual employees.

RRSP Asset Mix

Assets inside an RRSP tax shelter can comprise of many different savings and investment funds like:

  • Savings Account
  • Money Market Funds
  • Guaranteed Investment Certificates (GICs) 
  • Exchange-traded Funds (ETFs)
  • Equities and Bonds
  • Real Estate Funds
  • Etc.

What Are the Benefits of a RRSP?

The main benefit of RRSP would have to be the tax-free compounding growth of your investment inside the RRSP tax shelter. Your investment, together with its growth remain tax-free until withdrawal. In effect, RRSP is more of a tax-deferred shelter than straightforward tax-shelter due to its tax-implication at withdrawal.

Non-registered investment returns on the other hand, are generally taxable, which means that every time your money grows, you receive a tax-bill. A registered investment account like RRSP and TFSA lets you take advantage of tax-free growth of your investments without having to pay taxes every time your investment grows.

Another notable RRSP benefit that most high-income earners take advantage of is its ability to lower your income tax payable by simply making RRSP contributions to invest and save up for your own retirement.

Let’s say, as a taxpayer, your annual taxable income is $75,000.00 and your marginal tax rate is 37.9%. A $10,000.00 RRSP contribution will save you $3,612.32 on your tax bill. Not to mention the fact that the $10,000.00 you’ve invested inside your RRSP will grow over time in compounded returns which will be available to you as a source of retirement income in the future. You can compute your tax savings by using this RRSP Tax Savings Calculator.

RRSP Contribution Limits

The RRSP contribution limit for 2018 is 18% of an individual’s earned income from all sources. All individuals who earn and report their income receives a Notice of Assessment (NOC) from the CRA every year. This states your accumulated RRSP limit from when you first filed a tax return as a Canadian resident and no, you don’t have to be 18 to set up an RRSP account.

Your RRSP contribution limit for 2018 cannot exceed $26,010.00 or 18% of your previous year’s income. Your total contribution limit could be more if you don’t max-out your maximum allowable contribution every year as CRA allows you to carry forward your unused RRSP contribution room indefinitely. You can check your Notice of Assessment to know your total RRSP contribution limit to date.

Contributing more than your limit is possible but may incur penalties if your RRSP over-contribution amounts to more than $2,000.00. You cannot claim RRSP tax deductions for the excess contribution and you will be subject to 1% RRSP over-contribution penalty every month for the amount in excess of $2,000.00.

If you over-contributed to your RRSP, you must submit a T1-OVP Individual Tax Return for RRSP Excess Contributions to calculate the amount of the over-contribution and penalty tax.

RRSP Withdrawal

A Registered Retirement Savings Plan, as the name implies should be withdrawn to supplement your retirement income and since most people’s marginal tax rate is expected to be lower at retirement compared to when they were actively working; it is expected that your RRSP tax payable at withdrawal to be lower than when you’re actively working.

This tax deferral system of the RRSP program aims to encourage people to save for their retirement and not expect the government pension(s) to be their sole source of income at retirement because even the government agrees that government pensions alone aren’t enough to fully support a person’s financial needs at retirement.

Canadian residents who save and invest for their retirement in an RRSP account benefit from tax-free growth of their investment, tax-deduction incentive against their taxable income at the year of contribution and potentially lower tax bills upon withdrawal when withdrawn at retirement.

There is no restriction as to when you can invest or withdraw money from inside the RRSP shelter, you may invest or withdraw money from your RRSP account as you please, but you have to keep in mind that though you enjoy income tax-deductible contributions, withdrawals from an RRSP account is fully taxable. This is because your money in an RRSP is pre-taxed dollars. Remember, the CRA lowered your income tax-payable at time of contribution? That’s the government returning you taxes you already paid on the part of the money that you earned because you contributed into your RRSP.

Two Ways to Withdraw RRSP Tax-free

  1. RRSP withdrawal through the Home Buyer’s Plan
    You can use up to $25,000.00 of your RRSP (capital + investment returns) tax-free to put down as a down payment to buy your family’s residence. If both you and your spouse have contributed to RRSP, you can withdraw a total of $50,000.00 as a couple to help finance your home.

    To qualify, the RRSP funds you’re withdrawing must be inside the account for at least 90 days. You must also present a signed agreement that you are indeed purchasing or building a qualifying home.
    Your withdrawal will remain not taxable if you return the funds into your RRSP within a period of 15 years starting the second year of your home purchase. Every year, you will be required to pay at least one-fifteenth of the amount withdrawn. The best way to set this up is to set up a pre-authorized contribution arrangement every on a monthly or bi-weekly basis into your RRSP so you never miss a payment for your RRSP Home Buyer’s Plan.

  2. Another way you can make a tax-free withdrawal of your retirement savings in an RRSP is through the Life Long Learning Plan or LLP.
    The LLP allows you to withdraw funds from your RRSP tax-free when you decide to go back to school to further your education or for a career change.

    The Life Long Learning Plan works similarly to the RRSP Home Buyers Plan, where you can withdraw your principal and gains from your RRSP to help you finance your own or your spouse or common-law partner’s education.

    This program allows you to withdraw up to $10,000.00 per the calendar year to a maximum total limit of $20,000.00 and unlike the RRSP Home Buyer’s Plan where you can only qualify one time, the LLP allows you to avail of its benefits again after your RRSP.

Why You Should Repay Your RRSP Tax-Free Withdrawal

Some people are turned off by the fact that they must repay their withdrawals for the RRSP Home Buyer’s Plan and the LLP, stating that it’s their own money they’ve withdrawn.

While this reasoning is partly true, here are the reason why you should repay your own RRSP contribution:

Repaying your own money inside your retirement account is good for you, otherwise, you will have less money at retirement.

While it’s your own money that you’ve withdrawn, you must remember that the money you used was pre-taxed dollars since the government basically returned your taxes on that money when you first made your RRSP contribution.

If you’ve been contributing for a while and you’ve benefited from investment gains, you must remember that your money grew tax-free inside the RRSP shelter and the money you withdrew tax-free may already be the tax-free gains that you would have paid taxes on otherwise.

While the government will NOT force you to repay what you’ve withdrawn through either the RRSP Home Buyer’s Plan or the Life Long Learning Plan, you will be billed for the unpaid taxes on your withdrawal.

RRSP at 71

What happens to your RRSP at age 71?

At age 71, you can no longer shelter your tax-free accumulated investments inside RRSP. That’s the bad news! The good news is, aside from simply withdrawing a lump-sum and paying taxes on that withdrawal, you can always roll-over your RRSP into an RRIF or an annuity.

An RRIF or a Registered Retirement Income Fund is RRSP’s counterpart at the withdrawal phase of your retirement planning journey. It’s technically a similar account, just with a different name, account number and a minimum withdrawal rule(s).

Keep in mind that with an RRSP, the letter “S” stands for “savings” and the “I” on an RRIF stands for “Income”. When you were actively working, and you started “saving” into your RRSP, you were at the “saving” phase of your retirement planning; when you turn 71, you will be at the “income” phase of your retirement.

You will not be taxed when you convert your RRSP into an RRIF until the time of withdrawal. The major difference between an RRSP and RRIF is that you will have minimum required withdrawals as mandated by the Federal government.

You will have to withdraw a certain percentage of your fund’s year-end balance from the previous year:

  • 5.28% at age 72
  • 6.58% when you turn 80
  • 10.99% when you turn 90

This means that from the year you turn 71, going forward, you are encouraged to withdraw from your registered retirement funds.

Another way you can deal with your RRSP at age 71 is to use it to buy an annuity. An annuity is like a pension fund where you “trade in” your RRSP for a corresponding monthly income from an insurance company based on whatever your RRSPs fund balance at the time, the interest environment, your age and how long you’re expected to live.

You must keep in mind that when you “trade” or “exchange” your RRSP for an annuity that whatever money you have inside your RRSP will already be theirs. 

What you’ll get in return is the corresponding monthly, quarterly or annual income based on the amount of your asset.

An annuity is an excellent protection against the risk of living too long as whatever amount you’re receiving from your contract, you will keep on receiving as long as you live. However, some retirees are hesitant about handing-out their RRSP funds as a trade-off for annuities considering the possibilities that they may not live that long. 

To address this, insurance companies also offer annuities with guaranteed periods, so the payments continue for a minimum guaranteed period even if the annuitant passes-away prematurely.

The choice between an annuity or an RRIF will depend on a retiree’s individual situation and preference at age 71. 

Annuities and RRIFs are vast topics on their own that deserve their own individual articles but if you are currently on the saving phase of your retirement planning journey, understanding the basics of how an RRSP works is beneficial in planning your future.

If you’re looking to open an RRSP or make additional contributions, my team and I can help you set up one through Segregated Funds