For people who get excited about RRSPs, the new year brings RRSP season. It’s the window between now and the end of February when scrupulous savers can cram extra cash into their retirement accounts and still count their contributions toward last year’s taxes.
For many though, the new year might simply bring a resolution to start saving for retirement. If that’s you, you might have questions about the registered retirement savings plan, or RRSP. Let’s begin your journey toward becoming an RRSP fanatic with the basics:
What are RRSPs?
The registered retirement savings plan, or RRSP for short, is a tax shelter created by the Government of Canada to help you save for retirement.
When you contribute money to your RRSP, the tax on that money is deferred. You will receive a tax credit for every dollar you put into your RRSP, and the money in your RRSP will grow tax-free. You will then pay income tax on the money you withdraw from your RRSP in retirement.
RRSPs can hold more than just savings accounts. You can put GICs, stocks, bonds, mutual funds, ETFs, and lots of different investments in an RRSP.
How do RRSPs work?
RRSPs work much like many savings and investment products, with the added benefit of significant tax savings.
You can open one or many RRSPs with a bank, an investment adviser or a robo-advisor. Your RRSP provider will keep track of all your contributions and send you an RRSP Contribution Receipt in early March. When you do your taxes, you can deduct your RRSP contributions from your taxable income, which in turn will reduce the amount of tax you owe for the year.
While your RRSPs are invested, any interest earned is allowed to accumulate tax-free. You can invest the money in your RRSP in just about anything you want, with real property being a key exception.
When you retire and begin to withdraw from your RRSP, your provider will withhold income tax from your withdrawal much like your employer withholds income tax on your paycheque. At the end of each year, your RRSP provider will send you a T4 slip showing the total amount of money you withdrew from your RRSP in that year so you can do your taxes.
Who can open an RRSP?
If you are a Canadian citizen or permanent resident who is 18 years or older, and you have had employment income at some point in your life, you can open an RRSP.
It doesn’t matter whether you’re single or married. Each individual is entitled to their own RRSP.
Once you turn 71, you are no longer eligible to hold an RRSP, and the account must be converted to a different type of registered retirement account.
How much money can you contribute to your RRSP?
Your 2018 RRSP contribution limit is based on your income. Generally, you can contribute up to 18% of your earned income to your RRSP, up to a maximum contribution of $26,230 (for 2018). If you earned $50,000 before tax in 2018, you can contribute $9,000 to your RRSP.
Contribution room carries forward, too. Every year you earn income, you earn RRSP contribution room. You can find your total contribution room on your most recent notice of assessment (NOA).
You’ll want to keep a careful eye on your limit if you think there’s a chance you could go over. Any contributions in excess of your personal limit are penalized at a rate of 1% per month for every month until the excess amount is withdrawn or new contribution room opens up.
How much does your RRSP contribution reduce tax by?
When you do your taxes in April of each year, you calculate the amount of tax you owe by adding up all your taxable income and deducting credits. Comparing the amount of tax you owe for the year to the amount you’ve already paid determines whether you will get a refund or have a balance owing.
When you put money in your RRSP, your taxable income is reduced by the same amount as your RRSP contribution. If you earned $50,000 and contributed $1,000 to your RRSP, you’ll be taxed as if you made $49,000.
The exact amount your tax will be reduced by depends on your marginal tax rate, which is based on your income and varies by province or territory. Between federal and provincial taxes there are too many tax brackets to list here – there are ten tax brackets in British Columbia and eleven in Ontario – but if you’re really interested to find your own tax rate this website has them all listed.
That said, the tax savings are significant. If you lived in BC and earned $50,000 in 2018, a $1,000 RRSP contribution would reduce your taxes by $282. If you lived in Ontario and earned $100,000, a $1,000 RRSP contribution would reduce your taxes by $434.
Can you withdraw money from your RRSP?
Yes, you can withdraw money from your RRSP at any time. But that doesn’t necessarily mean you should.
A few things happen when you withdraw money from your RRSP.
First, is you are taxed on that withdrawal. Your RRSP provider will withhold income tax and you’ll have to add the amount of your withdrawal to your taxable income when you do your taxes.
Second, and more importantly, when you withdraw money from your RRSP you don’t get that contribution room back. Your contribution limit remains the same, and you’ll miss out on the years of investment income that money could earn between now and the time you’re ready to retire.
If you think you will need to take your money out before retirement, you should consider investing in a tax-free savings account (TFSA) instead.
Where can I learn more about RRSPs?
This Q&A only scratches the surface of RRSPs. If you’re just getting started, you don’t need to get into all the little rules and details. But if you’re interested, there are lots of little rules, tips, and tricks that you can use to get the most out of your RRSP.
To find out more, start with our RRSP education centre. There’s lots of information there, ranging from the basics to more advanced topics like investment options.