The RRSP (Registered Retired Savings Plan) is a financial account used to hold savings and investment assets. The Canadian registered account has special tax advantages and is a good choice for someone who is planning to save for their retirement.
Several types of investments including mutual funds, equities, and bonds are permitted in an RRSP. There is no minimum age to have an RRSP account and you can start investing early to attain maximum benefits.
RRSP- An overview
The RRSP account was introduced by the Canadian government in 1957 to encourage employees and self-employed residents to save for retirement. For most Canadians just depending on payouts from federal pension programs such as Old Age Security (OAS) and the Canada Pension Plan (CPP) are likely to be insufficient to lead a comfortable retired life.
The RRSP was launched in order to bridge this gap which also helps Canadians lower their taxes. There are several types of RRSP accounts- an individual RRSP is set up by a single person while a group RRSP is set up by an employer for employees and is funded with payroll deductions. In cases of spousal RRSPs, the higher earner may contribute to their spouse’s name while a pooled RRSP is for small businesses or self-employed people.
The contribution limit towards your RRSP account for any given year is either 18% of your past year’s income or a certain maximum amount, whichever is lower. For 2020 it is 18% of the total income an individual has reported on their 2019 tax return, while the maximum RRSP contribution amount stands at $27,230.
In case you contribute extra towards your RRSP account, then you get a $2000 cushion on your annual limit but it won’t be considered as tax-deductible. After exceeding this amount, you will be charged some amount of penalty by the Canada Revenue Agency.
You can contribute to this account until the age of 71, after which it will be converted into an RRIF (Registered Retirement Income Fund). The amount withdrawn from an RRIF is taxed at the marginal rate.
Benefits of an RRSP account
The main benefit of an RRSP account is that tax on RRSP contributions is deferred until retirement. It is essentially a tax-advantaged account which means that investing in this account will provide tax-breaks, motivating you to save for retirement.
Any capital gain you earn on your investment in the RRSP account will not be taxed until withdrawal. For example, if you have one share of a company and you make a $100 capital gain on this share, then in an RRSP account you will not be taxed while selling this share unless you withdraw it from the account. If you invest through a normal savings account then you have to pay a 50% tax on the gain. This means an RRSP account is tax-sheltered.
Further, any gain you make on your investments does not affect your contribution room. Your contribution limit depends only on the deposits you make in your account.
RRSP contributions are tax-deductible making it a good fit for high-income earners. For instance, if you are making $40,000 a year, you pay approximately a 20% tax on it. Now, if you contributed $5,000 in your RRSP, you can deduct that amount from your taxable income i.e. your net taxable income will now be $35,000.
According to WealthSimple, funds in a TFSA (Tax-Free Savings Account) are easily accessible so an RRSP account is perfect for someone who cannot resist completing their immediate goals or give in to temptations easily, failing to save for retirement.
When can you make tax-free withdrawals from the RRSP?
You have to start taking out your funds once you turn 71 years old when your RRSP will be converted into an RRIF. Apart from this, an RRSP account holder has been given two provisions to access their money other than withdrawing them after retirement and this can be done without paying taxes to the CRA.
The Home Buyers Plan allows individuals to withdraw up to $35,000 to buy or build their first home. The amount withdrawn has to be paid back within 15 years or the minimum annual payment will be added to your income and you will have to pay a tax on that to the Canada Revenue Agency. The repayment is not tax-deductible as you got the tax break the first time you put the money into your account.
The Life-Long Learning Plan (LLP) allows you to pull up to $20,000 and head back-to-school. You can withdraw up to $10,000 in any one year and this can be spread over 4 years. The repayment should be done within 10 years.
The final takeaway
You can withdraw money for various other reasons but then the withdrawals will not be tax-free and you will also lose that contribution room forever.
Anyone can take advantage of an RRSP account. You can enjoy the various tax benefits gained from RRSP. All in all, it is a great account to save money for the long run and help accelerate your retirement plans.