Are you one of those all-too-rare, yet lucky people who have a solid pension waiting for you when you retire?
For those of us who aren’t so lucky, it’s wise to start investing in RRSPs as soon as you start making any kind of income.
But what exactly is an RRSP? How do you know how much to invest, and where? Do you understand what an RRSP is and what it’s used for?
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What is an RRSP?
A Registered Retirement Savings Plan (RRSP) is a savings account that helps Canadians save money for retirement. Contributions to RRSPs are protected from income tax. There are many different types of RRSP investments. Any funds earned through these investments are also protected from tax for as long as they remain invested. This allows you to grow your portfolio in time to retire comfortably.
Are RRSPs really worth it?
The benefits of an RRSP
Investing in RRSPs, as early and as soon as possible, is the best way to make sure you will be able to eventually retire and still afford to live. But there are other, short-term benefits as well.
All money invested in an RRSP-sheltered product is untaxed. This means at income tax time, your income is lowered by the amount of money you contributed to your RRSP. This will ultimately lower the amount of tax you owe to the government for that tax year. While income tax needs to be paid when you withdraw the money, your income will be lower if you wait until retirement to touch it. Lower income means there is a smaller tax hit when you withdraw the money.
How much do you save on taxes with an RRSP?
How much you save on taxes in any given year is entirely dependent on how much you are able to contribute during that tax year. You are able to contribute up to 18% of your income to your RRSPs per year, plus you can carry over any unused contribution room from previous years. If you contribute the maximum, your income will be reduced by just over $25,000, thereby reducing your taxes.
What the actual savings will look like depends on what your total income is, but a $25,000 reduction in income is significant and will result in a large tax break.
Do I need an RRSP?
Typically speaking, yes. But, like most investments, it’s not a simple yes or no answer as to what makes the most sense for your lifestyle.
Long gone are the days when most jobs provided pension benefits to their employees. Some businesses offer full pensions, partial pensions or the ability to set one up for yourself. But, most of us will need our retirement income subsidized — either partially or completely — and an RRSP is the best way to do that.
Even when you do have a pension, while you will contribute less, it’s still advisable to have an RRSP. It is the best way to set yourself up for retirement as securely as possible.
How does the RRSP work?
You invest in RRSPs while you’re working and earning a regular wage. The intention is to leave that money alone until retirement, when you’re making less or no money (and likely have fewer expenses).
The money that goes into an RRSP is tax-deferred, which means it lowers your taxes when you make more money. And when you eventually withdraw it, you’ll be in a lower tax bracket because you’re making less — keeping more of the money you earned in your own pocket and out of the government’s.
Who can open an RRSP?
There is no minimum age at which someone can begin investing in RRSPs, as long as they have employment income and file a tax return. Where there is no minimum age to open an RRSP, there is a maximum: at 71 years old, RRSPs must be shut down. You can still contribute annually and have earnings throughout the year be tax sheltered. The account has to be shut down at the end of each year. It must then be invested elsewhere, or used as income.
When should I invest in an RRSP?
The main purpose of an RRSP is to save for retirement. The Government of Canada does allow for money for alternate purposes, including a tax-free withdrawal to purchase your first home. The Home Buyer’s Plan (discussed in greater detail below) allows you to make a tax-free withdrawal in order to purchase or build a house. The quicker you invest in an RRSP for this purpose, the more you will reap the full benefits.
If you’re investing for retirement, you should begin investing as soon as you receive your first paycheque. Even nominal contributions will help prepare you for a comfortable retirement down the line.
What can you use your RRSP money for besides retirement?
An RRSP is for retirement and can be used towards the purchase of a first home. But, there are other tax-free ways to withdraw your money early.
The Home Buyer’s Plan
Under the Home Buyers Plan (HBP), you may make a one-time withdrawal from your RRSP of up to $25,000 to put towards the purchase of your first home. The withdrawal of funds is tax-free but does need to be paid back in full within 15 years. In order to access the funds tax-free, they need to have been invested in your RRSP for a certain period of time.
You make minimum contributions to repay the funds every year. There is an exception to this rule for the first tax year after you make the withdrawal.
The federal government is currently considering increasing the amount one can withdraw from their RRSP for HBP to $35,000.
The Lifelong Learning Plan
The LLP was introduced to allow people to complete or enhance their education. The LLP allows you to withdraw up to $20,000 from your RRSP, tax-free, over a four-year span (but at a max of $10,000 per year) to pay for training or education. Funds can be put towards your own education or schooling for your spouse or common-law partner. It can not be used to finance your child’s education.
While the Home Buyer’s Plan allows 15 years for repayment, the LLP must be paid back in full within 10 years of withdrawal.
What is a spousal RRSP?
Spousal RRSPs are a form of income splitting. They don’t make sense for everybody, but if you are in a partnership where one partner earns significantly more than the other, a spousal RRSP might be for you. The idea is that the spouse with the higher income shifts some of that income to the lower-earning spouse, to lower their own tax bracket. They contribute to their spouse’s RRSP instead of their own, lowering their spouse’s taxable income, but deducting the contribution from their own taxes.
When it’s time to retire, the lower earner withdraws the funds. This results in less of a tax hit than the higher earner would incur. This is an added benefit and great option for couples where one person will likely always be the higher earner.
What is the difference between an RSP and an RRSP?
For many of us, when we first start to think about RRSPs, we don’t even realize that there is a difference between an RSP and an RRSP. We just think it’s two different ways of saying the same thing — but we’re wrong.
An RSP is a Retirement Savings Plan. An RRSP is registered. An RSP doesn’t necessarily have the same tax protections and includes any type of savings product that’s sole purpose is to save for retirement. There are different types of RSPs, of which an RRSP is one.
Whereas an RRSP has maximum annual contributions and tax savings, other forms of RSPs have no such restrictions.
RSPs come in many different forms, including, but not limited to:
Tax-Free Savings Account (TFSA)
A TFSA can be a retirement savings tool, though that is not its main purpose. The CRA places annual limits on contributions. The limits change annually. Contributions to a TFSA are not tax deductible. Any interest made from contributions is free from taxation.
You can find the contribution limit for this year here.
Non-Registered Savings Accounts
Non-registered savings accounts allow for a wider variety of investments than a registered account. They are, however, subject to taxation on both the money that goes in and the interest earned. They have far fewer rules and restrictions governing them than a registered account, but they otherwise don’t offer the same tax benefits.
Registered Pension Plan (RPP)
An RPP is an employer benefit that helps employees save for retirement. There are two different types: a Defined Benefit (DB) Plan or a Defined Contribution (DC) Plan.
Defined Benefit Plan
Employees do not contribute to a DB. An employer will instead contribute to one based on a formula set out by the company, that will often include years of service, age, and salary as a guide. There are typically restrictions on how long you need to work at a business for a DB to be vested and/or ported should you leave the employer.
Defined Contribution Plan
These types of investments are employee-driven and the total pension amount is based on what the employee has contributed and the added earnings made off of that investment. Different organizations will have different rules surrounding what can or needs to be invested in a DC RPP. Employees choose how much money they will have deducted directly from their paycheque to contribute to their plan.
What’s better: RRSP or TFSA?
Like all investments, it depends on your contributions and long-term goals.
An RRSP is a retirement investment program. Any contributions to an RRSP are tax-deductible, but any withdrawals are subject to taxation. Contributions are for long-term investment. There is a penalty when they are withdrawn early.
In comparison, a TFSA will allow you to withdraw money at any time, so if you have a rainy day and need to tap into it, you won’t be taxed. That said, funds invested won’t be a tax deduction come tax time.
So, which is better?
If you have the confidence and ability to tie your money up long term, an RRSP has upfront tax benefits and long-term savings benefits. But if you want the ability to access your money in times of want or need without taking a financial hit to access it, a TFSA will make more sense for you.
What can I contribute to an RRSP?
Maximum RRSP contribution limit for 2019 and 2020
The amount you can contribute in any given year changes based on current government regulations and your previous year’s earnings and contributions.
The contribution limit for 2019 is 18% of the income reported on your 2018 tax return, up to a maximum of $26,500. That maximum will increase to $27,230 in 2020.
You can estimate your contribution limit with the help of an RRSP calculator.
How do you find out your own contribution limit?
There are a number of ways to find out how much money you can contribute to your RRSP in a specific year.
You will find your own personal RRSP contribution limit:
- On line A of your previous year’s Notice of Assessment
- By logging into your CRA My Account
- By calling the CRA’s Tax Information Phone Service (TIPS)
- On Form T1028, which you will receive in the event that your RRSP deduction limit has changed since your last assessment.
When is the deadline for an RRSP contribution?
It’s important to note that RRSP contributions can be made into the next calendar year, up until Mar. 1 of the following tax year. Next year’s RRSP deadline is Mar. 1, 2020.
What types of investments can I put in my RRSP?
The Government of Canada has strict guidelines about what investments are allowed to be held in an RRSP. Below are some of the more common types of RRSP investments.
Stocks are a common investment people have in their RRSPs. The cost of stocks and their ongoing value depends on the health of the stock market. The earnings of the corporations in which your money is invested plays a role, as well. They can be risky investments in an uncertain market. As far as long-term investments go, the benefit of stocks is that they will often have time to recover from downward market fluctuations or business-altering events.
Stocks are great investments for two reasons: First, you make money off of upward market trends, and the company in which you invest will often pay out dividends, making them additionally lucrative investments.
Bonds are investments into a government or corporation — a.k.a., a loan. In exchange for your investment, after a period of time you will get your money back, plus interest. They are long-term, fixed investments. As of 2017, Canada no longer sells government sales bonds, but other governments offer savings bonds, and Canadians are able to invest in them.
In order to invest in mutual funds, you need a money manager who uses pooled funds of multiple investors to invest in groups of stocks or bonds. Mutual funds are tied to a market or market sector. People invested in mutual funds are charged an annual fee by the fund managers.
Guaranteed Investment Certificates (GICs) are similar to bonds, in that you invest a certain amount of money, and in exchange for that loan, you earn interest. The key difference is that, instead of investing in a government agency or a company, GICs are investments in financial institutions.
So much to know
There’s a lot to digest when it comes to the ins and outs of investing in RRSPs. The best way to know you’re making the right choices for your income and lifestyle is to talk to a financial advisor and/or an investment advisor. They will help guide you through your short-term and long-term needs and how to best invest in your future.