RRSP – Registered Retirement Savings Plan
In Canada, life expectancy is constantly on the rise and now stands at 82.5 years. With a retirement age of 65, the average Canadian now has 17.5 years of retirement to enjoy, but also to finance. It’s no wonder, therefore, that the Government of Canada is trying to encourage its citizens to consider their retirement savings plans.
Retirement planning is something that many Canadians do not consider until retirement age is on the horizon. However, with smart financial planning and wise investments, your retirement could be as financially comfortable as your working life.
A Registered Retirement Savings Plan (RRSP) is one of the most favoured investments for retirement in Canada. Today, we will look at RRSPs and precisely what makes them so popular. Let’s begin.
What is an RRSP?
A Registered Retirement Savings Plan (RRSP) is a plan to help you save and invest for your retirement. It is available to anyone employed or self-employed in Canada. RRSP contributions can be made with your spouse or by yourself. Your pre-tax earnings are placed into the RRSP. Your RRSP balance will grow tax-free. They will then be tax deductible at the marginal rate at the time of withdrawal.
RRSPs are overseen by the Canada Revenue Agency (CRA). They are registered with the government of Canada. They are, therefore, subject to rules concerning annual contribution limits and contribution timing. There are various types of approved assets allowed in your Registered Retirement Savings Plan. These include:
- Mutual Funds
- Exchange-traded Funds
- Savings Accounts
- Mortgage Accounts
- Foreign Currency
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.
RRSP Contribution Limit
The RRSP contribution limit is the maximum amount of money you are allowed to pay into your RRSP account annually. The contribution limit differs from person to person. It is based on several factors, including the deduction limit for this year and any contributions that are unused from previous years.
The RRSP deduction limit changes each year. For 2020, the deduction limit was $27,230, whereas, in 2019, it was $26,500. The alternative RRSP deduction limit is 18% of your pre-tax earnings. Your limit will be based on which of these figures is lower.
For example, if your earned income this year was $100,000, 18% of this amount would be $18,000, so your deduction limit is this figure. However, if your earnings were $200,000, 18% would calculate to $36,000, so your deduction limit would be $27,230.
The contribution limit is different from the deduction limit. This is because it takes into account unused contributions from previous years. If you had an unused contribution in the previous year, room is made in this year’s contribution, and your contribution limit will be higher.
The Canada Revenue Agency keeps a record of individual RRSP contribution limits. You can find this information on your Notice of Assessment after you file your taxes each year.
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.
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.
How to Open an RRSP
If you have decided that an RRSP is the best retirement savings plan 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.
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
A Registered Retirement Savings Plan (RRSP) is a plan that is encouraged and overseen by the Government of Canada. It helps Canadians with financial planning for their retirement. These investments help you to save and invest for your retirement. RRSPs are a popular type of investment for many Canadians because of the extensive tax benefits you receive.
You can choose how much to invest in your RRSP to fit your current financial situation and future financial goals. Ensuring you have a comfortable retirement without the worry of affording Canada’s high cost of living is one of RRSPs’ most attractive qualities.