May 19, 2021
The RRSP is one of the best tools for Canadians to save for retirement. Here's what you need to know to get started.
In my previous article on the Tax-Free Savings Account (TFSA) a few weeks ago, I explained the various advantages, rules and misconceptions surrounding it. This week, we shift our focus on the more familiar Registered Retirement Savings Plan and will aim to explain the RRSP’s utility and limitations. In a later article, I will cover which account type is best suited for different savings & investment goals.
What is an RRSP and how does it work?
The Registered Retirement Savings Account (RRSP) is a registered savings account introduced in 1957 to help Canadians save for retirement by offering tax incentives for contributions to these plans. The principal advantage is that you get a tax deduction receipt for personal contributions to your RRSP which can be applied to lower the taxes owed on your income. These receipts can either be used in the year they were issued, or you can choose to carry forward your contributions and apply them to future years if you expect an increase in your tax rate over time. The deposits can be invested in various assets and will grow tax-deferred to maximize compounding. This means you will not pay taxes on your investment income in the year that income is earned which leaves more of your money to grow and compound over time.
Since RRSP contributions are tax-deductible, redemptions from RRSPs are also taxable as income in the year they are withdrawn unless the redemption qualifies for a special program like the Home Buyer’s Plan (HBP) or Lifelong Learning Plan (LLP)
What are the rules for RRSPs?
RRSPs are available to Canadian residents aged 71 and under who have earned an income, filed income taxes and have contribution room posted on their Notice of Assessment sent by the Canada Revenue Agency (CRA). You can have several RRSP accounts with different institutions, but your total cumulative deposits can’t go over your contribution limit without penalties. Although you can name a beneficiary of your choosing, there is a provision allowing a tax-free “rollover” of the RRSP assets if your spouse or common law partner is named as beneficiary.
Not all assets are permitted as investments in RRSPs. Cash, cash equivalents, mutual funds, securities listed on a designated stock exchange, bonds and some shares in small business corporations are permitted.
Contributions made to your RRSP in the first 60 days of a new year can be deducted against your previous year’s income. Contributions made after those first 60 days can only be used for the year they were made or carried forward to future years.
How much money are you allowed to have in an RRSP?
RRSP contribution room is equal to 18% of the previous year’s earned income, up to a specific dollar limit and is cumulative. It is reduced by contributions made to RRSPs and the pension adjustment for participants in a registered pension plan, The maximum RRSP contribution for 2021 is $27,830. Contributing more than the allowable amount can result in costly penalties.
You can also contribute to an RRSP under your spouse’s ownership. Spousal RRSPs are owned and managed by the receiving spouse but the tax deductions go to the contributing spouse. The contributing spouse needs to have RRSP contribution room available and if there is a redemption from the plan in the year of the last contribution or the next two calendar years, that amount will be added to the contributing spouse’s income in the year of the withdrawal.
The RRSP can be a great tool for retirement planning purposes but careful consideration of one’s tax situation, timelines and need for liquidity certainly need to be taken into account.
Author:
Marcel LeBlanc, CFP®, CIM® is a Financial Planner and Associate Portfolio Manager with Louisbourg Investments. You can find more from him on Facebook and LinkedIn. Comments or questions may be submitted to Marcel at marcel.leblanc@louisbourg.net, or he may be reached at (506) 383-5204
More articles from Marcel:
How To Create a Retirement Plan (3min read)
How Much Will I Need to Retire? (3min read)
This writing is for general information purposes only and is not intended to provide legal, accounting, tax or personalized financial advice. If you are not sure how to proceed with a request for further information, seek help from a professional. Any opinions expressed are my own and may not necessarily reflect those of Louisbourg Investments.