The cost of living is on the rise in Canada. Even if you make smart financial decisions throughout your working life, it can still be difficult to maintain your lifestyle and be financially comfortable based solely on the Canada Pension Plan (CPP).
Saving for your retirement can enable you to enjoy your retirement comfortably without worrying about your finances. Registered Retirement Savings Plans (RRSPs) are the most well-known retirement plans in Canada. By making RRSP contributions during your working life, you can accumulate savings and could even earn high interest on these savings.
Today, we are going to look at RRSPs in more detail and help you choose the best option for you.
Registered Retirement Savings Plan (RRSP)
A Registered Retirement Savings Plan (RRSP) is a savings and investing tool. It helps you to financially prepare for your retirement. It is available to any employed or self-employed people in Canada. You do not have to be a Canadian citizen to open an RRSP account. Anyone who is a Canadian resident for tax purposes and files income taxes in Canada can open an RRSP.
Pre-tax earnings are contributed annually to an RRSP and will grow tax-free until you withdraw the funds. Your RRSP withdrawals will then be subject to a withdrawal tax and the marginal tax rate.
RRSPs are managed by the Canada Revenue Agency (CRA) and overseen by the government of Canada. They are subject to strict rules concerning your RRSP contribution limit, which can vary from person to person. The growth of your RRSP balance can be determined by its contents, how much you contribute and whether you withdraw any of the funds early.
The Best RRSP Investments in Canada
There are various types of approved assets that you can contribute to your RRSP. The best investment type for you depends on your personal finance, your financial requirements and your risk tolerance. You may also want to consider your age and for how long your RRSP balance will be growing.
Some of the most popular types of investments include:
- Cash – This is the most popular way of contributing to an RRSP. You can contribute as little or as much money as you choose, as long as you are within the contribution limits.
- Guaranteed Investment Certificates (GICs) – This is a fixed-income investment. It provides a guaranteed rate of return on your initial investment. They are usually a low-risk investment.
- Mutual Funds – Mutual funds pool your money with other investors to invest in a portfolio of assets. They can be purchased at your bank, credit union or other financial institutions.
- Exchange-Traded Funds (ETFs) – An ETF allows you to invest in stocks, shares and bonds. They are funds that hold stocks and are traded frequently. The risk level can vary depending on your portfolio.
- Stocks – Owning a stock means you own a portion of a company. You may earn dividend payments from the company or you can sell the stock at a higher price and make capital gains. This is usually a high-risk investment.
- Bonds – This is a fixed-income investment that earns fixed interest. Although the return may not be as high as other investment types, they are lower risk.
- Savings Accounts – An RRSP savings account or an RSP savings account can earn interest on your principal investment. They are offered by banks and financial institutions and are very low risk.
- Precious metals– Gold and silver can be held in an RRSP, as long as they meet the investment grade. The regulations are strict and a third-party custodian must verify your investment.
RRSP Savings Accounts in Canada
An RRSP savings account can hold your cash savings and any other investments you may have. They are designed to encourage Canadians to save for retirement. RRSP accounts can be opened with all major banks and financial institutions.
An RRSP savings account is the easiest and least risky way to save money for retirement. Although they usually have a lower interest rate they are also risk-free. They are also a great way of accumulating money without paying taxes long-term.
By placing your contributions into this savings account, you are opting for a steady, risk-free way of growing your RRSP funds. If you do not want to worry about interest fluctuations or investment risk, this is a great option.
How Does an RRSP Work?
RRSP accounts are known as tax-advantaged accounts. This is because they were created to offer tax breaks to those who contribute to their RRSPs and save for retirement. Any money that you contribute to an RRSP will provide you with a tax deduction when you file your taxes. This means you will pay less income tax every year that you contribute to your RRSP.
An RRSP can include a savings account, a registered investment account and an account with an online brokerage. Any savings that you accumulate will be tax-deductible. Some RRSPs have a high interest rate, allowing you to accumulate more savings. Some accounts will have monthly fees so keep this in mind when you are deciding which RRSP is best for you.
The balance of an RRSP will grow tax-free until the balance is withdrawn. At this point, you will have to pay taxes on your withdrawal amount. The tax amount can vary depending on a number of factors. The benefit of only paying tax when you withdraw your balance is that the majority of people who are retired are likely to be in a lower tax bracket. If your taxable income is lower, you will pay less tax overall.
There are three main types of RRSPs to choose from:
- An Individual RRSP – This is an account for a single person who is both the contributor and the account holder.
- A Spousal RRSP – If you are married or in a common-law relationship, you can set up a spousal account and both receive tax benefits. A high earner can contribute in the name of a lower-earning spouse. The retirement income will be divided equally, and both you and your spouse can benefit from the lower tax rate.
- A Group RRSP – This savings account may be offered by your employer. It is funded by deductions from your pay. An investment manager will be in charge of the account. All contributors will receive instant tax savings. You may also receive matching contributions from your employer, resulting in more savings.
There is no minimum balance requirement or no minimum age for opening an RRSP account. You can make contributions until the last calendar day of the year you turn 71. Your contributions will continue to grow until this day. At this point, your account will automatically terminate and you will have several options available:
- You can opt to withdraw your balance in a lump sum amount. However, you will be subject to a withholding tax of up to 30%, as well as the marginal tax rate.
- You can convert your RRSP into a Registered Retirement Income Fund (RRIF). An RRIF gives you a steady income throughout your retirement. With this option, you will not be subject to a withholding tax.
- You can use the funds to buy an annuity. An annuity is purchased from an insurance company. They guarantee an income plus interest.
- You can transfer money from your RRSP into a Tax-Free Savings Account (TFSA). A TFSA is a popular option for those looking to withdraw funds. You can withdraw money from your TFSA without paying taxes. Although converting from an RRSP to a TFSA could result in financial penalties, these will be much lower if your TFSA and RRSP are with the same financial institution.
What is the Contribution Limit for an RRSP?
Your RRSP will have a deduction limit. This is the maximum amount you are allowed to contribute per year. This amount can vary based on your income, the deduction limit for this year and any unused contributions from previous years.
The deduction limit is set at either 18% of your pre-tax earnings or a maximum amount of $27,830. Your limit will be whichever of these figures is lower. The contribution limit is different as it takes into account unused contribution room from previous years. If you had unused contributions in the previous year, the room will be made in the current year and the amount you are able to contribute will be higher.
Can I Withdraw RRSP Funds at Any Time?
As long as your RRSP account is not locked in, you can withdraw funds at any time. However, there may be financial consequences if you do this. For example:
- You will lose your tax-sheltered compounding. Even a small withdrawal can have a huge impact on your overall savings.
- You will permanently lose your RRSP contribution room. This means you will not be able to recontribute the amount you withdrew.
- Your withdrawal will be subject to withholding tax and income tax. This could push you into the next tax bracket for that year.
However, it is possible to withdraw up to $35,000 without financial consequences in two circumstances.
- The Home Buyers Plan (HBP)– You can borrow up to $35,000, or $70,000 for couples. This money can be used as a down payment on your first home. The funds are considered a loan and you must repay the loan within 15 years.
- The Lifelong Learning Plan (LLP)– You can withdraw up to $10,000 for education or training. This is up to a maximum withdrawal of $20,000. Any funds that you withdraw are also considered a loan. It must be repaid within 10 years.
The Bottom Line
RRSPs help Canadians to financially plan for their retirement. You can save and invest money in a variety of ways, including an RRSP savings account, an RSP savings account, investments, a TFSA, stocks, bonds, and ETFs.
RRSPs are so popular because of the extensive tax benefits you receive. You can choose how much to contribute based on your personal finance, your current earned income and your future financial goals. Choosing the best RRSP savings accounts for you can be difficult. Consider the amount of time you have until retirement, your risk tolerance and the minimum balance you want to save.