Investing as a Canadian! RRSP

Since the beginning of the pandemic, investing, stocks, stock markets and cryptocurrency has been in the news and social media platform a lot more often and I think it’s worthwhile spending a bit more time on this overall topic. It is quite evident that not everyone has the same background and knowledge to be involved in ‘investing’ which puts those individuals at a disadvantage.

I’ll tackle the basics of what options are available for Canadians to start their journey in investing, no matter what their risk tolerances are!

Let’s start with WHERE you can invest?

As a Canadian, you have 4 large types of accounts; TFSA Account, RRSP Account, RESP Account and Margin Account. Let’s dig into each type and what they can be used for and what they offer as a benefit. In this article, we will cover the second type of Account: RRSPs and future articles to cover the remaining accounts.

[If you haven't read last week's article or would like to learn about TFSAs - you can read it here!]

RRSP

RRSP is an acronym that stands for Registered Retirement Savings Plan. This account is available to all Canadians who are residents, have a valid SIN and are of the age 18 or older. RRSPs are commonly referred to as "tax-advantage" account, which makes them VERY different than previously discussed TFSA accounts.

This is already confusing, what does 'tax-advantage' even mean?

In short, it's just a fancy way of saying that by contributing to a RRSP account, you can lower your taxable income for the current year. When you lower your taxable income, it leads to lower taxes*.

*not always the case as each person has their own other incomes and deductibles.

So, what exactly is a RRSP?

RRSPs were created by the government which allowed all residents to start planning for their retirement. It has a prime purpose; to enable you to save for your retirement and 'deferring' to pay tax.

Deferring = instead of paying taxes today, you pay it at a later stage i.e. when you withdraw from your RRSP at the time of retirement or in your retired years.

Alright, so how exactly does this work?

You decide how much you would like to contribute into a RRSP account. Many employers offer this, some employers offering RRSP matching (example: you put 3% of your income, and they will add another 3%). You can also create additional RRSP accounts through many banks or brokers and contribute more beyond what you have set up from your employers' side.

What happens after I decide to contribute to a RRSP account?

First, just like a TFSA, RRSP also has annual limits. You are allowed to contribute a MAXIMUM of 18% of your last year's income OR $27,230 - which ever is lower. Keep in mind that the fixed amount limit changes every year, but you can find the current details here (source).

Does each RRSP account has its own limits?

No! The limit is for all of your RRSP accounts combined. To avoid fees and penalties, do not go above your annual limit!

What can I buy within a RRSP account?

Depending on where your RRSP account is, you can buy stocks, mutual funds, ETFs, bonds or GICs. Typically, RRSP accounts offered through employers likely only allow you to hold mutual funds and bonds however individual RRSP accounts can offer all options.

Am I paying any taxes when it comes to RRSP?

No and yes! You are not paying taxes in the current year but when you do retire or withdraw, you will pay taxes in that year.

Whats the difference between TFSA and RRSP?

In simple terms, you use after-tax money when you use TFSA. But you use before-tax money when you contribute to RRSPs.

Here is an example: If you are making $60,000 a year from your job and you contributed 10% to RRSP which ends up being $6,000. For this current year, CRA will charge you income tax on $54,000 because you contributed to RRSP which is looked upon as a before-tax contribution.

Alright, this makes sense. Since it's saving for retirement, does that mean my money is stuck?

Yes and no! You can withdraw from your RRSP at any point if you wish BUT you will have to pay 20% as a penalty. For example, if you have $10,000 in your RRSP, once you wish to withdraw all of it, you will pay $2,000 in penalties (labelled as 'withholding taxes'). NOT ONLY THAT, the year you withdraw any money from your RRSP, the entire amount withdrawn will be added to your taxable income!

So to jump back in an example, if you make $60,000 a year and you withdraw $10,000 from your RRSP. CRA will tax you as if you made $70,000.

With RRSPs, you pay the tax on it in the year you withdraw!

Can I use my RRSP for anything else?

Yes! The government allows individuals to the following with the funds in their RRSP accounts:

1. withdraw it to buy your first home
2. This has a limit of a maximum $35,000 each however only for your first home purchase. 10 years repayment.
3. Go back to school to study (by converting it to a Lifelong Learning Plan)
4. This has a limit of $10,000 per year for a maximum of $20,000 tax free. 10 years repayment

That sounds too good to be true. Whats the catch?

Ah - that's right, there is a catch! Given that the government allows your to withdraw money from your RRSP without fees for those two purposes, the catch is you MUST contribute the entire amount back into your RRSP with a specified number of years!

1. If you withdrew from your RRSP to buy a house, you MUST pay back the entire amount borrowed within 15 years (source).
2. If you withdrew from your RRSP to go back to school, you MUST pay back the entire amount borrowed within 10 years (source).

So how do pick which is better for me between TFSA and RRSP?

It is unfair to compare the two accounts as they both are meant to do very different things. It also purely depends on your personal goals and total income.

Your TFSA grows tax free for ever because you pay tax on your entire income in the current year. So you may wish to use a TFSA if you have money on hand.

RRSPs are good to lower your taxable income. People often take advantage of their employer's matching and don't contribute excess to it (if employer matches only 3% of contributions, you put only 3%) under the assumption you will make more money in the future therefore will benefit higher returns after contributing to RRSP (because it lowers your taxable income).

Overall recommendation is generally to have both; RRSPs to be driven for retirement money and TFSAs for easy access money as there are no taxes or fees on withdrawing.

Did I miss something or do you have a question about RRSPs? Comment below and I can help you get answers!

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All illustrators were created and designed by JP! Follow his Instagram/Twitter for some fun comics!

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Disclaimer: the list above is not an exhaustive list nor to be considered as tax advice. Only use this list as a starting point to do your research and apply what is applicable to your personal taxes and personal scenarios.