Get the most out of RRSPs

19 October 2021 by National Bank
Drawing of a roadsign that reads RRSP

To get the most out of life when you retire, you need to plan ahead and make sure you still have money coming in. One of the very best ways to do that is to invest in a registered retirement savings plan—an RRSP. The great thing, too, is that you enjoy immediate tax savings. What is an RRSP and how does it work?

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What is the definition of an RRSP?

The registered retirement savings plan (RRSP) is a federal government program designed to encourage people to save for retirement. It provides special benefits as an incentive. RRSPs are like hiding money away in a shoebox—you put the money in and leave it there until you stop working.

The money in your RRSP can be used to purchase just about any type of financial product—shares, bonds, mutual funds, or more. You just leave it in the box and let the interest compound over the years to provide a portion of your retirement income. You can learn about compound interest by watching the video on our channel.

Do I pay less income tax if I have an RRSP?

Yes you do! That’s the main tax benefit. RRSPs are designed so that you pay less income tax now and possibly less later.

The reason is simple: all amounts you deposit in your RRSP are deducted from your taxable income. For example, if you make $50,000 a year and put $2,000 into an RRSP, you’ll only pay tax on $48,000. Plus any income your RRSP investments generate is also tax-free so long as you don’t withdraw it.

You only pay tax once you cash out, which is normally when you retire and set up a registered retirement income fund (RRIF). Since your income could be lower at that point of your life, your marginal tax rate will probably also be lower. So you’ll have less tax to pay then, too.

Are there any limits to RRSPs?

Can you put all your income into an RRSP and pay no income tax at all? No. There are a few rules.

The maximum RRSP contribution you can deduct

The annual contribution limit for RRSPs is the lower of the following two amounts:

Good to know :

  • If you don’t use all your contribution room in a given year, it continues to add up and you can use it some other year.
  • To be able to deduct your RRSP contribution from your taxable income in any given year, you must make the investment no later than 60 days after the next year has started.
  • You can find out how much contribution room you have by consulting your Canada Revenue Agency file or consulting the assessment notice you receive when your income tax return is processed.

Got the money to contribute the maximum? That’s great! But what happens if you overshoot and contribute more than what’s allowed? The government will generally not penalize you if the excess amount is less than $2,000. However, you will not qualify for an income tax deduction for that part in excess of your maximum amount.

If your contribution is more than $2,000 above the maximum deductible amount, a 1% tax penalty could be levied on the excess amount until it is removed from your RRSP. The tax must be paid within 90 days of the end of the year. If it isn’t, you could be charged a penalty and interest.

Cashing out is usually not recommended

Obviously, all the money in your RRSP is money that belongs to you. You can use it whenever you want to pay for whatever you want. If you take money out of an RRSP, you lose the benefits associated with it.

The money you withdraw will be added to your taxable income for that year, so you’ll have to pay the applicable income tax. What’s more, you can’t use that contribution room again by putting the money back in later.

What are the main types of RRSPs? Which one should I choose?

Looking to invest in an RRSP? Here are the different possibilities:

Group RRSP

This type of RRSP is provided by an employer to their employees as an incentive to save for retirement. Contributions are generally deducted directly from your pay. In most cases the employer also contributes to the plan, which is another form of employee remuneration.

Spousal RRSP

Married and common-law spouses can contribute to each other’s RRSPs. This is a way for couples to cut their income tax, particularly when one of the spouses earns more than the other. To learn more about this benefit, speak to your specialist.

Locked-in RRSP

If you leave a federally regulated employer and you have money in the employee pension plan, you may have the option of withdrawing the money from the employer’s scheme and managing it yourself. However, you must invest in a locked-in RRSP. Unlike a regular RRSP, locked-in RRSPs cannot be cashed out until you reach retirement age, except under rare circumstances.

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Who can invest in an RRSP?

It’s easy to invest in an RRSP, but it’s important to be aware of certain terms of use, which are clearly set out on the Government of Canada website.

What are the minimum and maximum ages for having an RRSP?

There is no minimum age for investing in an RRSP. If you have filed an income tax return before and you have employment or business income, you can start today.

Only employment income, business income, and unused RRSP contribution room are used to calculate how much you can invest in an RRSP. Income from investments or capital gains is not counted.

The maximum age for contributing to an RRSP is 71. Specifically, you must stop putting money into your RRSP as of December 31 of the year you turn 71. You may continue to contribute to your spouse’s RRSP if your spouse is not yet 71.

Can I earn too much or too little to contribute to an RRSP?

RRSPs are for everybody, no matter what they make. There is no minimum or maximum income limit for contributing.

However, remember that the main benefit of RRSPs is to delay paying tax on a part of your income. If your tax rate is low, either because your income is low or because there are lots of deductions you can claim, an RRSP may not be the best investment choice for you.

How can I open an RRSP?

As their name indicates, RRSPs are a “registered” product for enjoying certain tax benefits. The government must therefore be notified of the amounts you are investing.

You can open an RRSP yourself via your bank’s website or you can ask an advisor to do it for you. You may also open multiple accounts, although the total must not go over your maximum allowable contribution.

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When can I cash out my RRSP and how?

If you’re short of cash, you can withdraw money from your RRSP at any time, but that may not be the best solution—RRSPs are a savings tool for retirement, not a bank account.

You’re best to have a withdrawal strategy. Your retirement planning specialist can help you draw one up to maximize your income throughout your retirement years. They’ll take other things into consideration too, like other sources of income such as Old Age Pension, and obligations you may have such as income tax.

Putting money from an RRSP into an RRIF

Since the maximum age for contributing to an RRSP is 71, you’ll have to transfer money out of your RRSP by December 31 of the year you turn 71 and into a registered retirement income fund (RRIF).

While RRSPs are for saving money and growing your investments tax free so that you are ready for retirement, RRIFs are to provide you with an income once you actually retire. There are minimum amounts you must cash out each year.

Beware: If you fail to transfer money from your RRSP to an RRIF, you could suffer major tax consequences. Plan carefully.

Can I use my RRSP without paying income tax?

There are two situations where the government lets you remove money from your RRSP without paying income tax:

These programs come with numerous restrictions. Inquire with a specialist to decide what’s best for you.

In conclusion, when the government offers incentive plans for saving, like RRSPs for retirement, the plans are often very beneficial. Whether you want to find out more and invest now, talk to us. We’re always happy to answer your questions.

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