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 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 the RRSP 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 in Canada. 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. Read more about: “What do I need to open a bank account in Canada?“.
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.
Benefits of the Registered Retirement Savings Plan
RRSPs are popular with many Canadians who are looking to save for retirement. There are several benefits to contributing to RRSPs for your retirement income:
- Tax Benefits- Any contribution to your RRSP are tax-deductible. Additionally, your savings balance will grow tax-free. We will look more at the tax benefits later.
- Converting your balance – You can convert your RRSP balance to get regular payments when you retire. This ensures that you will still get a retirement income. Your RRSP will be converted into a Registered Retirement Income Fund (RRIF) or an annuity when you retire.
- You can borrow money from your RRSP – This can only be done for two reasons. If you are using the money to buy your first house or pay for education costs for you or your spouse.
- Different types of RRSP to suit your needs – There a four different RRSP savings accounts.
- An Individual RRSP is a savings account for a single person who is both the contributor and the account holder.
- A Spousal RRSP is a savings account where both you and your spouse receive a tax benefit. A high earner can contribute to an RRSP in the name of their spouse. The retirement income will be divided equally, and both you and your spouse can benefit from a lower marginal tax rate.
- Group RRSPs are savings accounts set up 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.
- Pooled RRSPs are savings accounts for small businesses or those who are self-employed.
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.
Over Contribution to RRSPs
If you exceed your contribution limit, you will have an excess contribution. If you exceed your limit by $2,000 or more, you will have to pay 1% tax per month on the excess. If you do not pay your tax within 90 days, you will then be subject to late fees, interest and penalties.
However, there are some exceptions where an over-contribution will be accepted.
- If you withdrew the excess money from your account – However, this withdrawal will be subject to tax.
- If you contributed to a qualifying group plan
- If the excess contribution was a result of a reasonable error, you could ask for the penalties to be waived.
- If the CRA believes you are taking reasonable steps to eliminate any excess contributions.
In the case of the last two exceptions, you must write a letter to the CRA, making a voluntary disclosure. You must give an explanation of why a reasonable error has been made or what steps you are taking to rectify the error.
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.
How to Open an RRSP
If you have decided what the best RRSP in Canada is for you, the next step is to open an account. First, there are some important steps you should follow.
- Shop around and research – Learn about the different RRSPs. Contact an education centre to help you make your decision. Contact banks, financial institutions and other RRSP providers and see if their rates or fees differ. Use the ‘contact us’ section of their websites to get specific information. You do not need to be a member of the financial institution or have a chequing account with that bank to open an RRSP account.
- Decide on how best to invest – Do you want to invest money into your RRSP? Alternatively, do you want to invest in mutual funds, stocks, ETFs, Guaranteed Investment Certificates (GTFs) or savings accounts? The type of investment you want to make will influence the type of RRSP you can choose.
- Plan your investment – This is a very important step. Think about your long term retirement goal. Having savings plans can very beneficial to ensure you have a guaranteed investment when you retire. Retirement planning can never be done too early. How much money do you want to invest each month/year? What type of investments do you want to have? Consider your personal finance, your tax bracket and your taxable income.
Once you have done these things, it’s time to open your account. To open your account, you usually have to make an initial contribution. You can set up a regular contribution from your chequing account or through your payroll. Alternatively, you can make annual payments manually.
RRSP Home Buyers Plan
The Home Buyers Plan (HBP) is a program from the government of Canada. It allows you to withdraw money from your RRSP to buy or build a home. You can withdraw up to $35,000 from your RRSP for this purpose. The withdrawal will be tax-free and should be used for the downpayment on your home. The HBP is considered a loan. This means you must repay the amount you have borrowed within 15 years.
In order to qualify, you must be a first-time buyer. If you are buying the house with another first-time buyer, you can both borrow from your RRSPs to a maximum of $70,000 total. The money must have been in your account for 90 days prior to your withdrawal. Two years after you have purchased your home, you must begin repaying the loan. These payments can be made annually.
RRSP vs GRRSP
GRRSP refers to a Group Retirement Savings Plan. They are similar to an individual RRSP, but with some key differences. The GRRSP is organized by your employer. It is usually part of a benefits package. Your RRSP contribution will be made via automatic deduction from your pay. Rather than one annual payment, which is typical of individual RRSPs, the GRRSP is deducted throughout the year.
You can choose how much or how little you want to contribute to your retirement savings. One of the biggest advantages of a GRRSP is the increased likelihood that you will stick to your retirement savings plan long-term. Each contribution can be paid in smaller increments. Additionally, automatic payments make more financial sense for many people. Paying a more considerable lump sum annually can be problematic for some and make them less likely to make their contribution.
However, some people prefer individual RRSPs. This is especially true for those who are likely to change jobs more than once in their working career. If you leave the company, you must open a new RRSP account and transfer your money over.
RRSP vs TFSA
A TFSA is a Tax-Free Savings Account. There are similarities to a Registered Retirement Savings Plan. However, many Canadians are unsure whether to use savings accounts or RRSPs for their retirement planning. Both TFSAs and RRSPs offer lower tax on your investment. However, they both have different benefits depending on your personal finance.
The main difference between the two is related to their contribution limits, restrictions on withdrawals, as well as some tax differences. A Tax-Free Savings Account is seen as being more flexible. This is because you can contribute and withdraw your money with no penalties. These tax-free withdrawals can be made at any time and for any reason. You can replace the amount at any time, as long as you have contribution room that year.
The TFSA also allows direct contributions up to $69,500, compared to $27,230 from the RRSP. Unlike the TFSA, RRSPs require you to pay tax when you make a withdrawal. However, there are some benefits to the RRSP. One of the biggest advantages is that you can claim tax deductions every year you contribute. RRSPs are also a great place to keep your equities from the United States.
Frequently Asked Questions
Who’s Eligible for an RRSP?
The eligibility requirements for RRSPs are less stringent than many other investments. If an RRSP is your chosen investments type, chances are you are already eligible to open an account. To be eligible for an RRSP, there are several criteria you must meet.
- You must be a resident of Canada for tax purposes.
- You are 71 years of age or younger. There is no minimum age limit.
- You should have an income and file a tax return.
How Much Will Having an RRSP Reduce My Taxes?
Contributing to an RRSP reduces your taxable income. When you make contributions to your account, you can claim them on your income tax return. You will then pay less on your income taxes. Often, you will get a tax refund. Your balance will grow tax-free until you make a withdrawal.
The amount an RRSP reduces your taxes depends on your income tax bracket. The higher your income and the higher your RRSP contributions, the lower your income tax will be. Depending on your pre-tax income amount, you can expect to receive 20%- 50% off your contributions back as an income tax refund.
What Happens to Your RRSP When You Retire or Die?
Upon retirement, you have several options of what to do with your RRSP. You can opt to withdraw some or all of your funds as cash. However, you will be charged a withholding tax rate of up to 30%. Alternatively, RRSPs can be converted into a Registered Retirement Income Fund. This will give you a steady income throughout your retirement and will save you money on the hefty tax rate.
Another option is to buy an annuity. This is a product purchased from an insurance company and guarantees an income plus interest. If an RRSP holder dies, it is possible to give the RRSP to a beneficiary on a tax-deferred basis.
Can an RRSP be Transferred to Another Person (Partner/ Child)?
You cannot transfer money from your RRSP to another person’s RRSP unless you share the same annuitant. Additionally, it is not possible to change the name on an RRSP account to another person’s name. This is also true of any spousal RRSPs that you may have been contributing to. The only exception to this is if the RRSP holder has died. In this case, their beneficiary can be given the money from their Registered Retirement Savings Plans.
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.