Registered Retirement Savings Plan (RRSP)

Key points to remember

Contributions are made with pre-tax Dollars. So you are getting an immediate tax relief by deducting your RRSP contributions from your income each year.

Contributions made to a RRSP reduce your taxable income. This means you may owe less tax or you may get a larger refund.

Because RRSP contributions are made with pre-tax Dollars, you won't pay tax on that money until you withdraw it. That applies to contributions and investment earnings too.

When you withdraw money in retirement, it's very likely the tax rate won't be as high as it would have been during your working years. So whilst not tax-free, the amount you pay should be significantly less.

Your contribution room each year is limited to the lower of either:

  • 18% of your income in the previous year; or
  • The maximum contribution amount for the tax year.

You can check your contribution room online using My Account on the CRA portal.

If you don't fully utilize your contribution room in one year, you can carry it forward for the future. If you are a member of a pension plan, the amount you can contribute to your RRSP will be adjusted.

You can withdraw money or investments from an RRSP at any age. But note that any amount withdrawn is taxable income in the year it is withdrawn. You will pay tax at the rate designated to you based on your current income.

The exception is that the money is to buy a house (under the home buyers plan) or to fund education for yourself or your spouse (under the lifelong learning plan). In these cases, you won't pay taxes on the withdrawals as long as the money is paid back within a specified time.

In the year you turn 71, after December 31 you will not be able to continue contributing to your RRSP. The options available to you are to withdraw the funds; purchase an annuity; or convert the RRSP into a registered retirement income fund (RRIF).

An annuity can be used to provide income in your retirement, and is purchased usually through an insurer. 

A RRIF also provides income in your retirement; it works in a similar way to an RRSP but you can only make withdrawals from it.

What is a RRSP (Registered Retirement Savings Plan)?

An RRSP is a retirement savings plan that Canadians can use and contribute to up to the age of 71. It’s known as a tax-advantaged account, as any income you earn on your savings or investments are exempt from tax until you make a withdrawal. Contributions to a RRSP can also be deducted from your annual income to reduce your taxable income.

It’s a nice advantage that you can lower your taxes for the year; and put more money (that isn’t taxed) into your RRSP. And that money will grow tax-free, until you retire or withdraw the money. Only at that point will you pay tax.

How does a RRSP work?

As an example, let’s say you make $60,000 a year and want to make the maximum contribution allowed into a RRSP. Assuming you made $60,000 the previous year, the most you can contribute is 18% or $10,800.

When it’s time to submit your annual taxes, the CRA will view you as having earned just $49,200. So not only will your taxable income for the year be lower, but the money contributed to your RRSP will be tax-deferred too.

This means you will have to eventually pay taxes on this money when you withdraw it in retirement. But the idea is that when you reach retirement, your income will be lower, so your tax rate will be lower and therefore the amount of tax you pay will be lower.

Making contributions

The amount you can contribute to an RRSP depends on a few things. The first is your income history. You can contribute 18% of your income earned in the previous year, but the CRA also defines a maximum amount which changes each year.

The second depends on whether you have any unused contribution room from previous years. If you do, you can take advantage of that amount and add it to your contribution for the current year. Note that exceeding your contribution limit by over $2000 will incur a penalty fee. This tax charge is usually 1% of the excess contribution per month.

How much you decide to contribute to your RRSP depends on your personal circumstances. If you can afford to contribute the maximum amount and don’t need access to it until you retire, go for it! A general rule is to save between 10-15% of your income for retirement. But that depends on your age, life goals and any financial commitments you may have.

It’s very important to consider your financial commitments and current needs first. As an example, it may be better to focus on paying off debt before contributing to an RRSP. A financial advisor can help determine the best approach for you.

Note that if you have a Group RRSP, some employers match a portion of your contribution, around 1-5% of your salary. If this is true for your employer, try your best to contribute enough that your employer will pay the maximum. This is essentially free money!

Types of RRSPs

There are three types of RRSPs. The most commonly used is an individual RRSP, but it’s worth considering the other two options available.

Individual RRSP

An individual RRSP is an account registered in your name and you are the contributor. Any investments and tax advantages associated with them, are yours. You may choose to manage your investments with a self-directed RRSP.  You may also choose to work with an advisor or provider that will manage the portfolio on your behalf.

Group RRSP

A group RRSP is set up by an employer and contributions are automatically deducted from your pay. Your employer may match or add to your contributions. Management of the RRSP is usually done by an investment manager. Your employer will usually cover the costs of opening and managing the plan; though you may have to cover any investment costs.

There are a couple of limitations with a group RRSP. Depending where the group RRSP is held, the range of investment options may be limited. Rules may also exist for how much money you can withdraw and when; this is dependent on your employer.

Spousal RRSP

A spousal RRSP is an interesting way to split your retirement income with your spouse. This is beneficial as the combined income tax you pay as a couple might be lower than what you would pay if you were contributing to an individual RRSP. As the retirement income is divided evenly, both you and your spouse can benefit from a lower marginal tax rate.

A spousal RRSP makes sense if you are a high earner, or earn more than your spouse. This may mean you will be in a higher tax bracket when you both retire; and so the spousal RRSP can minimize the tax you pay. If both your income will be about the same at retirement, then opening a spousal RRSP may not be worth it.

Note that a spousal RRSP is usually registered in the name of your spouse. Whilst you contribute it, they will own the investments in the RRSP. You will tax deductions for any contributions you make; and this will reduce your own RRSP limit for the year. But that won’t affect how much your spouse can contribute to their own RRSP.

To qualify, you must:

  • Have lived together as a couple for at least 12 months
  • Have a child together by birth or adoption; or
  • Share custody and provide support to your partner’s children from a previous relationship.

If your relationship ends:

  • If married, then spouses will generally divide assets equally
  • If you are living common-law, assets may not necessarily be divided equally. So it’s worth drafting a joint agreement to cover this scenario.

If your spouses take out money you have contributed:

  • If within 3 years of the contribution date, you will have to pay tax on the amount withdrawn
  • If 3 years after the contribution date, your spouse will have to pay on the amount withdrawn

Self-directed RRSPs

A self-directed RRSP gives you more control choosing and managing the investments in an individual or spousal RRSP. It may be suitable if you are an educated investor; want a wider range of investment options; and have time to manage them. This means being comfortable making investment decisions on your own.

Fees can make or break your RRSP, whether it’s a standard or self-directed. Both will have an annual fee and fees for trades (particularly in a self-directed RRSP). But the management fee is the one to watch out for.

Management expense ratios or MERs for Canadian mutual funds are around 2%. This means that however well the fund performs each year, 2% will be deducted to cover expenses. Whilst this may seem low, it could eat a large chunk of your investment gains over time.

That said, you may choose to fill your self-directed RRSP with low-fee ETFs. These track stock and bond markets rather than trying to beat them like mutual funds attempt to do. Take the time to understand the fees associated with the different types of investments available to you. Additionally, find out about the fees for opening and managing a RRSP (whether standard or self-directed).

Setting up an RRSP

You can set a RRSP through a financial institution such as a bank, credit union, trust or an insurance company. They can advise you on the types of RRSP they offer and what investments they can contain.

Speaking with a financial advisor is also recommended. They can determine which is the best RRSP for you based on your income and what you can afford to contribute. They can also advise on fees and the investments you may wish to hold in your RRSP.

FAQs

RRSPs can hold savings and investments. An RRSP can hold cash; gold; GICs; bonds; mutual funds; ETFs to name a few. It cannot hold precious metals; commodity futures contracts; real estate.

Your RRSP provider can confirm exactly what is and isn't allowed to be held in your plan.

The marginal tax rate is the percentage of tax you pay on the last dollar of your income. As your income increases, so does the percentage of tax you pay on each additional dollar earned. It's a bit like climbing stairs: each step represents a different and higher income level. As you earn more (and take a step up), the government takes a higher percentage of your additional income.

As an example, if your marginal tax rate is 15% and you earn an extra $100, you would pay $15 in taxes on that additional amount. It's a progressive tax system, meaning those that earn more will contribute a high proportion of their income to taxes.

This will depend on your provider and what investments you may hold. There are four main fees you may incur:

  • Account setup: some providers may charge setup fee though there usually isn't a charge for opening an RRSP.
  • Annual admin or trustee fee: it's important you understand what this fee is before you open an account. If you have a group RRSP, your employer may cover this cost.
  • Investment costs: you will likely pay a commission when buying and selling stocks, or ETFs for your plan. Mutual funds have various fees too, such as a sales charge when you buy or sell them. Again, it's important to understand what fees will apply before you buy or sell an investment.
  • Miscellaneous costs: these fees are for services you may need, such as transferring money to a different RRSP or closing your RRSP.

If you setup an online account with the CRA, you can check your contribution room for the year. You can also view your income tax, benefits information, and your RRSP balance. It can even alert you if you've exceeded your contribution limit.

When you open an RRSP, you may choose to designate a beneficiary to receive the proceeds from your RRSP in the event of your death.

In this case, your RRSP will be rolled over to your beneficiary on a tax-deferred basis. If there is no beneficiary, the proceeds for your RRSP will be considered part of your estate and will be distributed accordingly.

Your estate's executor will prepare and file your final income tax return. The commuted value of your RRSP will be reported as taxable earnings on that final tax return.

This value represents the lump sum value of your future pension income today. It represents the present value of the monthly pension income you would have received in retirement.

Essential information

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