Retirement, or as we like to call it, the golden years, takes an awful lot of preparation to live comfortably after you stop working. You will likely need to start when you are young and well integrated into the workforce, and even that may not be enough if you aren’t using the right accounts to help your money grow. Building a retirement fund takes consistency, planning and most importantly, time!
In Canada, a few financial tools will help you succeed in your retirement. In today’s article, we will discuss one of the most touted financial: the Registered Retirement Savings Plan (RRSP).
This is a continuation of our TFSA article. So your financial success journey continues!
What is an RRSP
The RRSP is a unique savings plan registered with the Canada Revenue Agency (CRA) that you contribute to throughout your working life.
Money contributed to your RRSP is tax-deferred; in other words, you will not pay tax on any contributions and investments made within the account so long as it is not withdrawn (hopefully, years down the line). The upside to it is that these very same contributions are tax-deductible up to certain limits, meaning they can be deducted from your taxable income in the year they were made!
Types of RRSP’s
The RRSP comes in four basic types:
- Basic Plan
- Group RRSP
- Spousal RRSP
The basic RRSP plan is established to hold a specific investment product.
The self-directed RRSP is undoubtedly for you if you like to have more autonomy over where your money gets invested. This will require you to monitor your investments and have the knowledge to design the appropriate asset allocation.
The Group RRSP is sponsored by an employer and is a collection of individual RRSPs. While it has the advantage of immediate tax savings, some plans may be limited in their investment options.
Though registered as two separate RRSPs. In certain situations, spouses or common-law partners may contribute to their partner’s RRSP. This has several benefits, mainly when the couple uses an income splitting strategy where they leverage the income of the higher earning partner and the contribution room of the lower income partner to reduce their overall tax liability.
Setting up An RRSP
Opening an RRSP in Canada can be very simple.
You can choose several different financial institutions, and setting up your contribution amount can be done without a hitch. What is essential to do on your end is to shop around decide what kind of account you will have and what investments will be suitable for you. You will be much better positioned to succeed with your investments if you can do that.
RRSP Contribution and Deduction Limits
The RRSP comes with loads of great benefits, but there is a limit to how much you can contribute and deduct each year unique to your financial situation.
Before we begin, we should clarify what an RRSP deduction and RRSP contribution limit are. Though generally conflated as the same thing, they are, in fact, different. A deduction limit is the maximum amount you could deduct from your income in any given year.
The RRSP contribution limit is the amount you can deposit into your RRSP in any given year.
As a general guideline, the allowable contribution for your RRSP is calculated as the lesser of:
- 18% of your earned income for the previous year
- the maximum contribution limit for the current year
For 2022, the RRSP contribution limit 2022 is a maximum of $29,210. In many ways, the higher the tax bracket you are in, the more advantageous the RRSP is. Let’s look at how this plays out:
Here, we are comparing the income of two people (Mark and Cindy):
(Lesser of 18% and $29,210)
Though a very basic example, you can see that the idea is that the higher the tax bracket, the higher the tax savings if you were to deduct. This is not meant to discourage you from contributing to your RRSP if you are in a lower bracket but gives you a realistic idea of where people generally make the most of this particular feature of the account.
If you are below a certain threshold (below $48,500 by some expert’s point of view), an RRSP may not make much sense to get initially. However, you can load up your TFSA in the meantime while you increase your income.
For a more detailed look at your retirement contributions and deductions, certainly, speak to a financial planner to help get a retirement plan that conquers.
Eligible taxpayers must make their contributions by March 1, 2022. If you are unsure about how much you can contribute, don’t worry, CRA will send you a Notice of Assessment, or you can log into your CRA account for an account overview.
What Happens When I Over Contribute to My RRSP?
The great thing about the RRSP is that your unused contribution room can be carried forward in the next tax year. So, if you have a contribution room of $9,000 and only contributed $4,000, you will be able to carry an additional $5,000 on top of your annual limit. While that can be advantageous especially as you earn more income, you should also be wary over contributing to your RRSP. Without incurring any tax, you can over contribute up to $2,000.
Anything over this amount will be subject to a 1% tax per month. Because the way in which an RRSP is set up, if you do wish to withdraw the excess funds, they will be added as taxable income the year they are withdrawn from your account.
Note: Any over contributions are not considered tax-deductible. The benefit to some is the opportunity to have more money growing on a tax-deferred basis.
Investing With Your RRSP
Like the TFSA, the RRSP can hold several different qualified investments. They include:
- Guaranteed Investment Certificates
- Exchange-traded funds
- Mutual funds
There are several investments known as non-qualified investments that cannot be held within your RRSP. Think of assets like commodity futures contracts, personal property, or shares of many private corporations. If you do happen to acquire a non-qualified investment, there is a tax that will be imposed of 50% of the fair market value (FMV) when it was acquired or became non-qualified (YIKES).
RRSP Home Buyers Plan (HBP)
If you consider buying a home, you can leverage your RRSP to help you get there.
The Home Buyers Plan (HBP) allows you to withdraw up to $35,000 from your RRSP to build or buy a qualifying home. As a loan, you are required to repay the amount withdrawn within no more than 15 years.
Here’s the upside: when you withdraw from your RRSP using the HBP, you do not have to include the withdrawal in your income. If you are married or in a common-law partnership, you can access a cumulative amount of up to $70,00. You must stay informed on the eligibility rules and requirements before considering using this method to purchase your first home.
RRSP Life Events
When to Use Your RRSP
Once you retire, your RRSP is turned into what is called a Registered Retirement Income Fund (RRIF). This is a trust designed to give the annuitant (you) income. While the RRSP holds your investments, the RRIF is what you will use to reap the benefits of your hard work. Deciding when to roll over your RRSP into an RRIF can be tricky. Here are a few things to know before making that decision:
- Your RRSP matures fully at the age of 71, so you can continue making contributions up to that point.
- Any withdrawals made from an RRIF are taxed. You should measure this against any other income sources you have.
You may have other tax savings strategies you may want to use, including income splitting with your spouse or common-law partner.
RRSP When You Pass On
Generally, your RRSP is rolled over to a beneficiary tax-deferred when you pass. There are many specificities to this, including whether the RRSP is matured vs unmatured, so we suggest you read the CRA’s guidelines on this exact topic.
The RRSP is a significant financial vehicle to leverage for your retirement. Half the battle is knowing, and the other is taking action to shape your future. If this resonated with you in any way, leave us a comment and let us know if there are any other topics you want us to touch on!