What is an RRSP?
An RRSP is a Registered Retirement Savings Plan. It is a financial structure intended to encourage people to save during their peak earning years for their retirement, when their income will likely be lower. To encourage people to use the plans, the federal government makes contributions to the plan deductible for income tax purposes (funds are taxed on withdrawal). Interest earned within the plan is tax free until withdrawn. Because interest is reinvested within the plan, plan value can grow considerably with time. At the end of the calendar year in which you turn 71 (before 2007, it was 69), you must stop making contributions and convert your RRSP to an income stream – a Registered Retirement Income Fund (RRIF) or an annuity.
Because most people will be in a lower income tax bracket during retirement than they are during their peak earning years, income deposited into the plan will ultimately be taxed at a lower rate than it otherwise would have been, reducing overall taxes. The RRSP also provides a tax deferral.
What are the rules for RRSPs?
Anyone over age 18 who earns income that would be taxable in Canada – even if they earn too little to pay tax – is eligible to contribute to an RRSP. You can contribute to plans in your name and in your spouse’s name.
You can contribute to your RRSP up to 18% of your previous year’s earned income (as defined by the Canada Revenue Agency) up to a maximum, which in 2019 is $26,500. Your employer may also contribute to an RRSP on your behalf; these contributions are included in your contribution limit. Pension adjustments may also be calculated that change the amount you can contribute (essentially, the more you will receive from an employer pension, the less you can contribute to your RRSP).
You can make lump-sum transfers to your RRSP from a Registered Pension Plan or a Deferred Profit-Sharing Plan. You can also freely transfer funds among various RRSPs or Registered Retirement Income Funds (RRIFs) you own.
If you do not make the maximum allowable contribution to your RRSP in any given year, you can carry the unused room forward. You can also contribute and use the deduction in later years when your income is higher and the deduction will be more useful to you, as long as the contribution is within your accumulated contribution room. You are allowed to over-contribute $2,000, beyond which you will pay significant tax on the over-contributed amount.
Taxation on withdrawals
You are allowed to take funds out of your RRSP before retirement, but be aware that the funds will be considered income and you must report them on your tax return for that year. In addition, the financial institution that holds the RRSP is required to withhold income tax in most circumstances. The more you withdraw, the higher the percentage tax withheld: if you take up to $5,000, withholding tax is 10%. If you take more than $15,000, 30% will be held back.
You are allowed to contribute funds to an RRSP in your spouse’s name; you claim the tax deduction. One benefit of doing this is income splitting: if your spouse will be in a lower tax bracket than you during retirement, funds withdrawn from your spouse’s RRSP will be taxed at a lower rate. Even if you are over 71, if your spouse is under 72 you can continue contributions to his or her RRSP if you have contribution room.
Although your spouse owns all assets in the spousal RRSP regardless of who contributed them, any funds withdrawn will be taxed in your hands up to the amount you contributed in the past three years; this is called the three-year attribution rule.
Many types of investments can be made within an RRSP: savings accounts, term deposits, guaranteed investment certificates, bonds, stocks and various types of mutual funds. With a self-directed plan, you decide what you invest in. If you participate in a group RRSP with your employer, an investment manager may make all the decisions.
Foreign investments used to be limited to 30% of your RRSP, but that restriction was lifted in 2005.
Except for contributions made in the previous 12 months, RRSPs are protected from creditors if the plan owner declares bankruptcy. RRSP holdings may not be protected from non-bankruptcy creditor actions, however, especially if they relate to matrimonial property or family maintenance/support; rules vary by province.
Talk with your financial advisor regularly about your RRSP to make sure it’s set up the best way possible for you.