RRSP basics

As tax season is around the corner, a lot of “experts” urge us to contribute to our RRSP. But what is an RRSP?

RRSP stands for Registered Retirement Savings Plan. It is the most popular way to save for retirement in Canada. It was introduced in 1957.

As indicated in its name, the plan is registered with Canada Revenue Agency. It works on a tax-deferred basis, i.e. money is only taxed when withdrawn. The interest earned is tax-free and re-invested into the plan.

Any type of investment is possible, such as cash, bonds, mutual funds, term-deposits, GIC’s…

In order to open an account, you need to have earned an income in the previous year. The contribution limit is 18% of your income for the previous year, to a maximum amount set by CRA – $ 24 930.00 for 2015-. If you do not contribute the maximum amount, unused contributions can be carried over for the lifetime of the plan. You can find the exact amount on your Notice of Assessment.

The main advantage of an RRSP is that contributions are tax deductible. They reduce your taxable income and potentially lower your tax payable. You don’t have to use your contributions as a tax-deduction if you haven’t earned a lot of money in a given year. You can defer the amount to a future year.

Be careful not to over-contribute. If you do so, you will have to pay 1% per month on any contribution exceeding $ 2 000.00.

The purpose of an RRSP is to supplement your government benefits during retirement. Ideally, you should never withdraw money from it until that time. If you take money out, you will have to pay taxes and report the amount on your next tax return. The current federal tax rates are:

• 10% on the first $ 5 000.00
• 20% up to $ 15 000.00
• 30% on amounts over $ 15 000.00

You may have to pay additional fees and taxes, depending on your province of residence and the type of plan.

Two programs allow you to withdraw money from your RRSP without the tax implications: the Home–Buyer Plan, for first-time home-buyers, and the Lifelong Learning Plan to finance education.

It is also possible to have a Spousal RRSP. This plan is only interesting if one partner makes more money than the other or has a pension plan. The partner who earns more contributes to the RRSP of the other and takes the tax deduction. When the partner who earns less withdraws the money, it will be less taxed. It is the basis of income-splitting.

Some companies also offer Group RRSPs. Usually, contributions are taken out of your paycheque. Your employers may or may not match them. Since your employer manages the plan, you may have a limited choice of investments. There may also be other requirements. A group RRSP only makes sense if your employer also contributes.