Natasha Macmillan, Business Unit Director - Everyday Banking
A registered retirement savings plan (RRSP) is a government-approved account that helps Canadians to plan for retirement. First introduced in 1957, RRSPs provide a way for individuals to save and invest their money in a tax-efficient manner. Annual contributions to an RRSP can be used as a tax deduction, which reduces the amount of tax a person will pay on their income. In addition, all capital gains and dividends aren’t taxed as long as the money remains in the RRSP.
How does an RRSP work?
Every year, Canadians with “earned” income (salaries or wages from a job) who file a tax return may contribute money to an RRSP. The contribution limit is defined as either 18% of your previous year’s earned income or a specified amount set by the Canada Revenue Agency (CRA), whichever is less. Here are the annual contribution limits since 1991:
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This contribution may then be used as a deduction when filing for the previous year’s taxes. For example, if you contribute $2,000 to your RRSP, your income is then reduced by $2,000 for the purpose of calculating the tax you owe.
Canadians are permitted to hold a wide variety of investments in their RRSPs. Some common RRSP investments include:
- Stocks listed on major Canadian foreign exhanges
- Bonds (government and corporate)
- Savings bonds
- Mutual Funds
- Exchange-traded Funds (ETFs)
- Index Funds
- Gold and silver bars
- Income trusts
RRSPs may remain open until a person reaches the age of 71. At this point (by the end of the calendar year), they must be closed or converted into what’s known as a registered retirement income fund (RRIF).
How do I open an RRSP?
There are five steps to opening an RRSP:
- Shop around for the best plan—Before opening an RRSP, you’ll want to look into what’s offered by various financial institutions. Shopping around allows you to see what investments they offer and what fees you’ll pay.
- Consider the kinds of investments you want to hold—You can buy stocks and bonds, among many others. The investments you purchase should be based on your risk tolerance and investment objectives.
- Decide on an RRSP and financial institution—You’ll require two pieces of identification to open an RRSP, one of which must be government-issued
- Fill out an RRSP application—You’ll have to answer questions about your level of investment knowledge, your investment goals, and your RRSP beneficiary. The financial institution may ask to see a copy of your most recent notice of assessment from the CRA.
- Open the account—To put money into your new RRSP, you’ll have to transfer money in or make a contribution from another RRSP account you already have.
An RRSP may be opened at most financial institutions in Canada. These include banks, trust companies, insurance companies, investment firms, and credit unions/caisses populaires.
How is an RRSP structured?
With a wide variety of investments to choose from, there are many ways to structure an RRSP. As a general rule, you’ll want to have a mix of assets, such as stocks, bonds, and cash. You can buy either individual stocks and bonds. Or you can purchase a basket of them in an ETF, mutual fund, or index fund.
The younger you are, the more risks you can probably afford to take with money in your RRSP. However, as you near retirement you’ll probably want to shift your portfolio to safer investments to be sure you’ll have the money when you reach the age of 71.
There are three main benefits of having an RRSP:
- You get a tax deduction—Contributing to an RRSP gives you a deduction when you file your taxes. What this means is that your taxable income is reduced, which lowers the amount of tax you’ll pay. It may also put you into a lower tax bracket.
- Money grows tax-free—As long as the money remains in your RRSP, all capital gains and dividend/interest income won’t be taxed. This allows your RRSP to grow significantly until such time as you either withdraw money or reach the age of 71.
- Tax deferral—Money held in an RRSP (both the contributions and investment gains) won’t be tax-free forever. You’ll pay tax on the money when you withdraw it, presumably at retirement. However, for most people their marginal tax rate will be lower in retirement, so by deferring the tax until you’re older you will end up paying less.
A great way to save
RRSPs are a great way to save. They save you money on your taxes today, and allow you to efficiently save for your retirement. By starting early and making steady contributions, you’ll build up a nest egg you can rely on when you reach your golden years.