An RRSP is a type of investment account registered with the Canada Revenue Agency. It offers tax advantages to help you save for retirement. Contributions to your RRSP can be deducted from your taxable income. The growth on your investments is tax-deferred until you withdraw the money in retirement.
The RRSP was created in 1957 as part of the Canadian Pension Plan. It is designed to encourage Canadians save for retirement by providing them with a tax shelter for their investments. In the early years of the RRSP only workers who were members of pension plans could contribute to an RRSP. However, the rules were changed in 1971 so that all Canadian workers could contribute whether they belonged to a pension plan or not.
How does an RRSP work?
Every Canadian resident who earns eligible income (employment, self-employment, and certain other types of income) in a given calendar year generates contribution room. That contribution room is equal to 18% of your annual income up to a maximum that adjusts each year ($29,210 for 2022). Your contribution room accumulates and is not lost if you don’t make a contribution.
When you make an RRSP contribution you receive a tax deduction on your annual income for the same amount when you file your taxes. If you make a contribution during the first 60 days of the year you can use them on your previous year’s tax return. There is also a second type of RRSP known as a Spousal RRSP. It is an effective income splitting strategy which will be the subject of a future post.
You are able to purchase and hold a wide range of investment types in your RRSP like GICs, bonds, stocks, mutual funds, and ETFs; which grow to help fund your retirement.
Are you allowed to make withdrawals from an RRSP?
You are allowed to make withdrawals at any time, but you will lose that contribution room forever. Beginning at age 55 you are able to convert your RRSP to a Registered Retirement Income Fund (RRIF). The year you turn 71 it is mandatory to convert your RRSP to a RRIF. Once converted the is a minimum amount you are required to withdrawal. All withdrawals from an RRSP are taxed as income in the year of withdrawal at your marginal tax rate. I will share the characteristics of a RRIF in a future post.
What are the benefits of an RRSP?
The benefit most people focus on is getting a tax return on your contribution amounts. The other benefit you receive is tax-free compounding growth. The amounts you contribute grow tax-free until they are withdrawn in retirement or sooner, if needed. This benefit can be significant over time and is greater the higher your marginal tax rate is. These incentives encourage Canadians to save and plan for retirement.
An RRSP can be a great way to save for retirement, but it's important to understand how they work before opening one. Withdrawals are possible at any time, but should be a last resort since you never get the contribution room back and lose out on the benefit of tax-free growth. If you would like to learn more about RRSPs or would like to evaluate your RRSP strategy, please reach out to me through https://www.planningandinvesting.com/contact.
Bobby McBride holds the Certified Financial Planner (CFP) designation and is Financial Planner at Planning with Bobby Inc. He also holds the Chartered Financial Analyst (CFA) designation and is an Investment Advisor at Investing with Bobby of Designed Securities Ltd.
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