Finance

Registered Retirement Savings Plan (RRSP): Important Things to Know

Registered Retirement Savings Plan (RRSP) Important Things to Know

No matter where you live in Canada post retirement, you need to have a retirement corpus to see you through. Investing in stocks is a good option but you can try other avenues as well. A Registered Retirement Savings Plan (RRSP) is a retirement savings and investing vehicle that is meant to serve the post-retirement income needs of employees and the self employed population of Canada. Pre-tax money is placed into an RRSP and grows tax-free until withdrawal, at which time it is taxed at the marginal rate. Registered Retirement Savings Plans can be considered similar to the 401(k) plans which are popular in the United States of America. However, they do have some key differences.

Registered Retirement Savings Plan (RRSP): Important Facts to Consider

What is a Registered Retirement Savings Plan (RRSP)?

A Registered Retirement Savings Plan, popularly known as the RRSP, is a type of financial account in Canada that holds savings and investment assets. When compared to investing beyond tax-preferred accounts, RRSPs have numerous tax advantages.

The growth of an RRSP is determined by its contents. Simply having money in an RRSP is not a guarantee that you may retire comfortably; however, it is a guarantee that the investments will compound without being taxed, as long as the funds are not withdrawn.

When were the Registered Retirement Savings Plans (RRSP) launched?

As a part of the Canadian Income Tax Act, Registered Retirement Savings Plans were launched in 1957. 

Who governs the Registered Retirement Savings Plans (RRSP)?

The RRSPs are supervised by the Canada Revenue Agency (CRA) and registered with the Government of Canada. The CRA does the job of setting the rules that govern annual contribution limits, contribution timing, and the type of assets that are allowed.

What are the tax advantages of Registered Retirement Savings Plans (RRSP)?

RRSPs come with two great tax advantages. First, contributors may deduct contributions against their income. For example, if a contributor’s tax rate is 40%, every $100 he or she invests in an RRSP will save that person $40 in taxes, up to his or her contribution limit. Second, the growth of RRSP investments is tax-sheltered.While returns earned from most non RRSP investment tools are always taxed, returns earned from RRSPs are exempt from any capital gains tax, dividend tax, or income tax. This results in all RRSP investments compounding at the pre-tax rate.

Essentially, contributors to the RRSP delay tax payment until retirement. At that point of time, their marginal tax rate is a lot lower than the time they were working. The government of Canada has provided this tax deferral to Canadians to encourage saving for retirement, which will help the population rely less on the Canadian Pension Plan to fund retirement.

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What are the different types of Registered Retirement Savings Plans (RRSPs)?

There are a number of RRSP types, but generally, they are set up by one or two associated people (usually individuals or spouses).

  • An Individual RRSP is set up by a single person who is both the account holder and the contributor.
  • A Spousal RRSP provides benefits for a single spouse and also a tax benefit for both spouses. A high-earner (spousal contributor) may contribute to a Spousal RRSP in their spouse’s name (the account holder). Since retirement income is divided evenly, each spouse can benefit from a lower marginal tax rate.
  • A Group RRSP is set up by an employer for employees and is funded with payroll deductions, much like a 401(k) plan in the U.S. An investment manager administers Group RRSPs and provides immediate tax savings advantage to the contributors.
  • A Pooled RRSP is an option created for small business employees and employers, as well as the self-employed.

What are the approved assets under Registered Retirement Savings Plans (RRSP)?

The different types of investment and investment accounts allowed under RRSPs are:

  • Mutual funds
  • Exchange-traded funds
  • Equities
  • Bonds
  • Savings accounts
  • Mortgage loans
  • Income trusts
  • Guaranteed investment certificates
  • Foreign currency
  • Labor-sponsored funds

What are the contribution and withdrawal limits for Registered Retirement Savings Plans (RRSP)?

The RRSP contribution limit for 2020 is 18% of the earned income an individual has reported on their 2019 tax return, up to a maximum of $27,230, according to the Canada Revenue Agency. It is possible to contribute more, but additional sums over $2,000 will be hit with penalties.

An RRSP account holder may withdraw money or investments at any age. Any sum is included as taxable income in the year of the withdrawal, unless the money is used to buy or build a home or for education (with some conditions).

What are Registered Retirement Income Funds (RRIFs)?

In the year an RRSP holder turns 71, the RRSP balance must be liquidated or shifted to a Registered Retirement Income Fund (RRIF) or to an annuity. An RRIF is a retirement fund similar to an annuity contract that pays out income to a beneficiary or a number of beneficiaries.

Money withdrawn from an RRSP through RRIF account payouts is taxed at the account holder’s marginal tax rate. For example, a 65 year old account holder with $300,000 saved for retirement will get around $1,000 per month from the RRIF. If this $1,000 is the only source of income, the account holder will be taxed at a marginal rate of 15%, leaving about $850 every month. Monthly Canada Pension Plans are also available for the account holder.

Registered Retirement Savings Plans (RRSP) vs. 401(k)s

As we discussed earlier, Registered Retirement Savings Plans (RRSP) share a lot of similarities with the American 401(k)s, but they have some important differences as well. Let’s have a look at them:

  • RRSPs can be created by financial institutions, 401(k)s are always created by employers.
  • RRSP contribution limits have the option to be carried forward.
  • RRSP contributions may come from payroll deductions or cash contributions (which may lead to a tax rebate); 401(k)s are funded with payroll deductions.
  • RRSPs don’t have any early withdrawal penalties, 401(k) on the other hand, always have early withdrawal penalties (barring a few exceptions).

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