Understanding RRSPs: All You Need to Know

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Last Updated on August 4, 2021 by Yetty Akindele

RRSP stands for Registered Retirement Savings Plan. It is a scheme provided by the government to Canadians as a sheltered plan to help save for retirement.

The plan was implemented in 1957 and is a supplement to a workplace pension. Prior to its implementation, pensions were mainly given by private institutions.

Those who had no pensions or personal savings and were over 70 had to resort to the $20 a month means-tested Old Age Pension plan introduced in 1927.  This is now known as the Old Age Security with some added changes.

Contributions to RRSP are tax-deductible. This means that any amount contributed to your RRSP account can be claimed as a tax deduction when filing your tax.

Additionally, returns generated in the account further stay tax-free. As long as you do not make withdrawals, your retirement savings continue to grow.

Generally, the longer you’ve had your RRSP account opened with regular contributions, the more retirement savings you are able to accumulate over the years.

Hence, it is recommended to start early. This allows the account to have tax savings for contributions, tax-sheltered earnings, and compound interest, making it easier to materialize retirement goals.

Types of RRSP Accounts

The top metrics that define the type of RRSP account are the contributors, the decision-makers on investments, and how the funds in the account are pooled together. Let us take a look at the different types of RRSP accounts;

1. Individual

An individual RRSP account is a type you open by and for yourself. Essentially, it is the type you open in your name.

You commit to making contributions to this account in lieu of your retirement. With this account type, you enjoy all of the tax benefits that come with the investment.

2. Spousal

You can contribute to your spouse’s RRSP account and vice versa. This is a way to split the retirement income – such that your cumulative tax burden as a couple is lower at the time of retirement.

3. Group

An employer can offer a group RRSP plan. This enables the employees to save for retirement. The employer may also contribute to the account. Employee contributions for their retirement savings are achieved through payroll deductions.

What Is The Current RRSP Contribution Limit?

Currently, for the 2019 tax year, the government allowed a contribution of 18% of earned income up to $26,500 if paid in 2019. This is capped at $27,230 in 2020 and $27,830 for 2021.

Earned income comprises of business income, alimony, royalties, rent, salary, etc.

It is not compulsory to use up your allowable contribution room. There is the option to carry forward the contribution indefinitely and contribute more in the years that follow. As a reminder, contributions can be done until the age of 71.

To determine what amount you can contribute, you can get this from your ‘My Account’ with the CRA. There are also some other important details to take note of regarding RRSP. These are listed below;

Over Contributing To RRSP

When you contribute more than the allowable contribution room to your RRSP account, there is a penalty tax of 1% monthly, for excess cumulative contributions that exceed $2000.

The wiggle room for $2000 is however made available before you begin to pay penalties. So, depending on the situation, it might be advisable to withdraw any excess amount over the figure of valid RRSP contributions + $2000, to avoid the penalties.

Are RRSP Withdrawals Taxable?

Withdrawals from the RRSP account can be done at any time.  However, following withdrawal, taxes become instantly due.

The tax amount is subject to the amount that is withdrawn. Financial institutions hold back the taxes and pay them back to the government on the withdrawer’s behalf.

You’d find that more taxes are due at the time of tax payment, because, the funds withdrawn are now a part of your taxable income. This is subject to your tax bracket.

It should also be noted that when you make a withdrawal from your RRSP account before retirement, that portion of your contribution room is lost permanently.

Can RRSP Withdrawals Be Non-taxable?

The Canadian government offers some room to make withdrawals from your RRSP account without having to pay taxes or losing the contribution room. Among the most important of such plans are;

Home buyer’s plan (HBP)

HBP allows a first-time homebuyer to withdraw up to $35,000 from their RRSP account to buy or build a home.

This can be for yourself or for a relative with a disability. If a couple withdraws an amount, they can each withdraw $25,000 that is $50,000 in total. Money withdrawn from RRSPs under the HBP must be paid back within a 15-year window.

Lifelong Learning Plan (LLP)

Under this plan, you are permitted to withdraw an amount of up to $10,000 in a calendar year from your RRSP account. The amount you withdraw cannot exceed $20,000 in total for an individual.

This is used for payment of your own full-time higher education/training or that of your spouse or common-law partner. If the situation pertains to you both, you can withdraw up to a total of $40,000.

The amount withdrawn is meant to be paid back within 10 years.

What Tax Benefits Does An RRSP Have?

RRSP account brings in three-fold tax benefits.

1. The contributions are tax-deductible

The contribution that is made to the RRSP account is pre-tax income or non-taxable income. In case any taxes are incurred, the amount is paid back at a marginal tax rate.

You can reduce the taxes at the source itself, and get a refund. Waiting for tax time is not required to get tax benefits. Overall, your income tax is lower.

2. Tax-free growth

The dividends, capital gains, and interest income that you get in your RRSP account are all tax-free. It continues to compound until the time of retirement, as long as you don’t make a withdrawal from the RRSP account.

3. Income splitting

At retirement, you can have a reduction of your family’s total tax load by making use of spousal income splitting. This is most crucial if one spouse is in a higher tax bracket.

RRSP Account Investment Options

  • Opening an RRSP account is easy. You have a choice of going for a direct plan. In this case, it is your bank or credit union that will put your money in an investment asset. This could be the option of a traditional savings account. However, it is advisable to open a high interest, no monthly fee RSP account.
  • Alternatively, you may choose to have a self-directed RRSP account. In the case of a self-directed RRSP account, you stay in charge of asset allocation and investment purchases in your account. You are the controller of your investment portfolio and can decide on how to invest the money by yourself. You could invest in no fee ETFs using DIY online brokerages. Two online brokerages popular among Canadians are Questrade ($50 in free trade on account opening) and Wealthsimple.
  • A more recent alternative for an RRSP account is through Robo-Advisors. As compared to the options available with active wealth management, Robo-Advisors invest your funds at a lower fee. Moreover, by using the services of Robo Advisors, you stay secure against the hassles involved with the self-managed approach. Again, 2 of the top leading Robo-advisors in Canada with affordable MER are Wealthsimple and Questwealth.

Additionally, before opening a RRSP account with any financial institution, you need to do your due diligence. Make inquiries about any fees attached to the opening and management of a RRSP account.

Non-permissible RRSP Investments

A few investments are not permissible for RRSP accounts. They characteristically fall in either the prohibited or the non-qualified category.

To safeguard against being dinged, it is important to ensure that thorough research is done before making any investments. For instance, Over-the-counter (OTC) markets traded investments are not qualified for RRSP accounts.

The following are examples of penalties levied over non-qualified or prohibited investments:

  • 50% tax over an investment’s fair market value
  • 100% tax over the income that an investment earns

How To Withdraw Money From An RRSP At Retirement

Upon retirement, you have the choice of doing one, or a combination of three things with money in your RRSP account;

The cash can be withdrawn as a lump sum.

In this case Canada Revenue Agency or CRA levies taxes on the cash. This is based upon your marginal tax rate.

Transfer the funds to RRIF

You can convert your account from an RRSP to RRIF, which is a Registered Retirement Income Fund. On a tax-deferred basis, your funds will stay invested in the RRIF account. In this case, you are required to withdraw a minimum amount of money from the account yearly. A record of this appears on your tax return.

Invest in an annuity

It is a fine idea to invest in an annuity at the time of retirement. This delivers income for you during retirement. You have a choice at investing in a life annuity or a term certain annuity.

What Happens To My RRSP Contributions If I Die?

In numerous cases, the RRSP account cashes out by the time the owner dies. The proceeds are then added to your estate. This can then be made available to your estate beneficiaries as stated in your Will. On your last income tax return, they’re taxed as well.

A couple of scenarios may take place, depending on who your beneficiaries are, in case you have designated them:

Qualified Beneficiary

In case you designate your spouse as your beneficiary, they should be able to transfer the funds into their RRIF or RRSP while maintaining the tax-deferred status. While they don’t withdraw the money, taxes won’t be due.

There are similar options available for financially dependent children who are beneficiaries of this plan. They can cash out the amount, transfer the RRSP into a Registered Disability Savings Plan (RDSP), or purchase an annuity before the age of 18.

Non-Qualified Beneficiary

A non-qualified beneficiary could be a financially dependent adult child or grandchild, your estate, or charity. For each of the transfers made to a non-qualified beneficiary, the RRSP’s full value is reported in your final income tax return. It is accordingly taxed.

With the insights that are given above, availing yourself of the many tax benefits associated with having money saved in a RRSP account cannot be overemphasized. Retirement planning is crucial and while you can start at any time, starting early is more beneficial.

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