What is an RRSP? And is it right for you?

A Registered Retirement Savings Plan (or RRSP for short) is a savings account that’s registered with the federal government and provides investors with several tax advantages.

As its name suggests, it’s designed to help Canadians save for retirement by providing tax breaks so that their savings grow faster and they’re able to enjoy a more comfortable retirement.

A Registered Retirement Savings Plan is quite a complex financial tool, however, and many people are unaware of its benefits and its limitations. We take a comprehensive look at how an RRSP works, how much you can contribute to an RRSP, the pros and cons of an RRSP and whether an RRSP is the right saving strategy for you.?

How does an RRSP work??

An RRSP is a retirement savings plan that you register with the federal government and make contributions to. The idea is that you use the RRSP to save money during your working life, then use those savings to supplement your other retirement income, such as a company pension, Canada Pension Plan or Old Age Security.

One of the key benefits is that any contributions you make to your RRSP are tax deductible — this means that the amount you save every year reduces the amount of income you earn, from a taxable point of view. This means the amount of income tax you’re liable for is reduced, with some people receiving a sizeable tax refund if their RRSP contributions are large enough.? ?

Another key advantage of the Registered Retirement Savings Plan is that all growth in the account — including interest, dividend payments and capital gains (which help your investments grow in value) — is tax deferred. This means that you won’t pay any taxes on the increase in your investments’ value, until you make withdrawals from the plan. This means that your investments can grow faster, as their gains are not reduced by taxation.

When it comes time to retire, investors typically convert their RRSP investments into a Registered Retirement Income Fund (RRIF) and/or an annuity, which in turn provides a regular retirement income. Most people convert their RRSP into a RRIF or annuity at some point in their 60s, but by law you must convert it before you turn 72.

To qualify to open an RRSP, you need to:

• Be a Canadian resident and have a Social Insurance Number.
• Earn income and file a tax return.
• Be 71 years old or younger.

What investments can you hold in an RRSP?

There are several investment options for your RRSP beyond just cash. And, given that many people will be investing in their RRSP for several decades, it might make sense to hold some investments that have the highest growth potential.

You can include the following investments in your RRSP:

• Cash savings accounts.
• Guaranteed Investment Certificates (GICs).
• Government and corporate bonds.
• Mutual funds.
• Exchange-traded funds (ETFs).
• Individual stocks that are listed on designated stock exchanges .

It’s really important that you don’t include any non-qualified investments in your RRSP, as this can lead to adverse tax implications. Your financial advisor or financial institution can help ensure you only hold qualified investments in your RRSP.?

What is the RRSP contribution limit?

As with the Tax-Free Savings Account (TFSA), there is a limit to how much you can contribute each year, and that limit changes from year to year.

The most you can contribute to an RRSP is the smallest amount of either:

• Up to 18% of your earned annual income.
• The annual RRSP contribution limit (which is $30,780 for 2023 ).

However, this is just your annual contribution limit. If you don’t contribute the maximum amount allowed in any one year, the shortfall can be rolled over to subsequent years, giving you more contribution room. Therefore, if you’ve been earning a wage for many years but never maxed out your RRSP contributions, you could have an RRSP contribution limit that is far higher than the annual amount.

There are several ways to discover exactly how much you can contribute to your RRSP:

• Your most recent notice of assessment (the RRSP Deduction Limit Statement).
• Your Government of Canada My Account .
• The MyCRA mobile app .
• By calling the CRA at?1-800-959-8281.

What is the RRSP deadline?

You have up to 60 days after December 31 to make your RRSP contributions for the previous year. For the 2023 tax year, the RRSP deadline is February 29, 2024.?

How do you withdraw money from an RRSP?

Given that Registered Retirement Savings Plans are designed to provide income in retirement, the most common way to withdraw money from an RRSP is to convert it into either a RRIF or an annuity, when you retire. You would then either receive regular annuity payments or make withdrawals to provide retirement income.

When you do this, withdrawals or annuity payments are considered income and will be subject to income tax. The plus side is that your overall retirement income should be lower than when you were working, so you should be in a lower tax bracket.

You can also withdraw money from your RRSP at any time, but you will pay a price. Not only will you have to include the withdrawal as income on your tax return, but your financial institution will also hold back some of the money in the form of a withholding tax . This is essentially an estimate and prepayment of the income taxes you may owe when you eventually file your income tax returns. The withholding tax increases as the amount you withdraw increases:

(These rates are 5%, 10% and 15% respectively in Quebec, plus provincial tax.)

Given that the withdrawal is also treated as income, you could end up paying more than 30% in tax if it bumps you up to a higher tax bracket.

However, there are a couple of instances where you can withdraw money from your RRSP before retiring without paying withholding or income tax.

The Home Buyers’ Plan allows you to withdraw up to $35,000 to use as a down payment to buy or build your first home. There are a few conditions that you would have to meet , such as being considered a first-time homebuyer and using the home as your primary residence, plus you would have to pay the money back into your RRSP within 15 years.

The Lifelong Learning Plan is a program designed to help older students participate in full-time education. You can withdraw up to $20,000 over a four-year period to finance full-time training or education for yourself or your spouse.?You do need to meet certain conditions, such as enrolling in a qualifying educational program at a designated educational institution, plus you’ll need to pay it back within a 10-year period.

What is a spousal RRSP???

You can make contributions to your spouse’s (or common-law partner’s) RRSP. If you earn more than your spouse, you get to help them build up their retirement savings while receiving a tax break (your contributions are deducted from your total taxable income for the year). Your spouse is likely to be in a lower income tax bracket than yourself when they withdraw the funds after they retire, which means more tax savings.??

The benefits of RRSPs?

While RRSPs aren’t beneficial for everybody, they do offer significant advantages for many investors:?

• The tax benefits of deducting contributions from your taxable income and allowing your investments to grow tax deferred are key advantages of RRSPs. Your savings typically grow considerably faster than they would in non-registered accounts.
• If you don’t max out your contributions, the shortfall is added to the amount you can contribute going forward.
• You can choose from a wide variety of investments.
• Your savings are protected from creditors if you ever have to file for bankruptcy.
• You can use the money to buy a first home or pay for full-time post-secondary studies.
• Spousal RRSPs can reduce your overall taxes, now and in retirement.
• Withdrawals from RRIFs can be split with your spouse, for income tax purposes.

What are the disadvantages of an RRSP?

Registered Retirement Savings Plans also have some drawbacks, particularly when compared to TFSAs or non-registered accounts:

• Contribution room can be limited if you’re a high earner, with the RRSP contribution limit being well below 18% of your salary.
• There is less freedom in how you can withdraw from an RRSP, compared to a TFSA.
• Withdrawals are classed as taxable income (unlike TFSA withdrawals).
• Low-income earners pay a low rate of income tax, so RRSPs don’t make financial sense for this kind of investor (a TFSA would probably be a better option).
• After you convert your RRSP to a RRIF, you must make minimum withdrawals each year (and those amounts increase each year), whether you need the money or not. This could also bring about clawbacks from benefits such as Old Age Security and the Guaranteed Income Supplement.?

Is an RRSP really worth it?

For many people, an RRSP is an extremely efficient way of saving for retirement and certainly worth it. The advantage of each annual contribution reducing your taxable income, plus your investments growing tax-free until you withdraw from them, mean that your investments grow faster than if you were to put them into non-registered accounts.

For people on a low income, however, a TFSA would probably be a better saving option. A key benefit of an RRSP is that you receive a tax break when you’re earning (when typically in a higher tax bracket) and then pay income tax when you’re retired and in a lower tax bracket. For people in a low tax bracket, it probably wouldn’t make sense to open an RRSP, unless their higher-earning spouse was contributing to it.?

Getting started with an RRSP

While the Registered Retirement Savings Plan can be extremely beneficial for many Canadian investors, it’s also quite a complex investment option. Before opening an account, you should discuss with your IG Advisor how an RRSP will fit into your overall financial plan.

Your Advisor will also be able to confirm if an RRSP is the most suitable retirement savings strategy for you and recommend the best mix of assets to hold within it. Set up a meeting with your IG Advisor to discuss how opening an RRSP can help you to reach your retirement savings goals. If you don’t have an IG Advisor, you can find one here .?

This IG Insight is being shared by:

Sergiu is a senior financial consultant with IG Wealth Management where he partners with Canadian families, incorporated professionals and business owners with strategic advice and services to create and maintain a holistic financial plan. He brings over 25 years' experience in the financial services industry. Before joining IG in 2017 he worked at one of Canada's leading banks. Sergiu is a Certified Financial Planner and a Fellow of the Canadian Securities Institute . Sergiu is based in Richmond Hill, Ontario and operates in the broader GTA.

Sergiu's contact details can be found on his web-page .

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