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Registered retirement savings plans (RRSP) are an attractive way to save for retirement. That said, it’s important to note that there are a number of rules governing these accounts. Understanding these regulations will allow you to maximize your retirement savings while not incurring any unforeseen tax penalties.
Pretty much everything related to RRSPs is regulated by the Canada Revenue Agency (CRA), which administers tax laws for the federal government. This includes:
- Who can set up an RRSP
- How much an individual may contribute every year
- What kind of investments qualify for RRSPs
- Withdrawing money from RRSPs
- When RRSPs must be closed or converted into registered retirement income funds (RRIFs)
RRSP age limits
With RRSPs, there’s no minimum age. As long as a Canadian has employment income and files a tax return, they (or their guardian) may set up and contribute to an RRSP. This contrasts with tax-free savings accounts (TFSAs), which require a Canadian to be at least 18 years of age.
However, there is a maximum age for RRSPs. When Canadians reach the age of 71 they must close down their RRSPs at the end of the calendar year. Those who have RRSPs have three options when they reach 71. They can:
- Collapse the RRSP entirely. In practice, this means withdrawing all the money in the account
- Use the money in the RRSP to purchase what’s known as an annuity
- Convert the RRSP into a RRIF
You’re allowed to designate one or more individuals as a beneficiary for your RRSP in case you die. If you don’t specify a beneficiary, the proceeds of the RRSP will form part of your estate and be divided accordingly.
There are three situations in which an RRSP can remain tax-sheltered upon your death:
- if your spouse is named as the beneficiary of your RRSP. The proceeds will be tax-sheltered so long as they are transferred from your RRSP to the surviving spouse’s RRSP or RRIF.
- If you don’t have a surviving spouse but have named children or grandchildren as beneficiaries. In this case, the proceeds from your RRSP will be transferred into a term annuity in their names.
- If you have children or grandchildren who, as a result of physical or mental illness, are financially dependent. They don’t have to be minors. In this case, the money will be transferred into an RRSP or RRIF and registered in their names. Alternatively, it can be used to purchase an annuity for them.
RRSP contribution rules
Every year, any Canadian is permitted to make a contribution to their RRSP. The amount of this contribution is the lesser of:
- 18% of earned income from the previous year, or
- the maximum amount as specified by the CRA for the year in question
Any unused contribution room carries forward for future years, meaning you don’t lose out just because you have not maximized your contribution in a particular year.
Keep in mind that any contributions from a group or company pension plan must be deducted if you are calculating how much you can contribute to an individual RRSP account.
The CRA lets Canadians know how much contribution room they have for the next year on their notice of assessment. Contributions must be made during a taxation year or within the first 60 calendar days of the next year in order to qualify for a tax deduction for the prior year’s taxes.
There are tax consequences for making an RRSP withdrawal before you retire. If you take money out of your RRSP early, you will be subject to the following taxes:
- Withholding tax: the financial institution at which you have your RRSP will hold back 10-30% of the withdrawal and pay it to the government. The amount withheld is dependent on where you live and how much you take out.
- Income tax: Money withdrawn from an RRSP is considered by the CRA to be taxable income. Depending on which tax bracket you fall into, you may be required to pay more tax when you file your return (in addition to the withholding tax paid when the withdrawal occurred).
Withdrawing money from an RRSP tax-free
There are two scenarios in which you can withdraw money tax-free from your RRSP:
- Home Buyer’s Plan: You are permitted to take out $25,000 from your RRSP in order to make a down payment on your first home. If you have a spouse, they are also allowed to withdraw this amount from their RRSP for this purpose. However, the borrowed amount must be repaid back into your RRSP within 15 years.
- Lifelong Learning Plan: You are also allowed to borrow up to $20,000 over the course of your life for the purpose of education and retraining. The maximum a person can withdraw in any year is $10,000 and any borrowed amounts must be repaid into the RRSP within 10 years.
It’s important to familiarize yourself with the key rules about RRSPs. Doing so allows you to use these structures to their maximum benefit while avoiding potentially costly pitfalls.