What is an RRSP?
A Registered Retirement Savings Plan (RRSP) is a valuable instrument for Canadians to build their retirement savings. Like other registered accounts provided by the government, it has some useful tax advantages to help you accelerate your savings.
An RRSP offers a strong incentive to save because the amount you contribute is tax deductible, thereby lowering your taxable income, reducing your taxes, and putting more money in your pocket. You can contribute up to the lower of $31,560, or 18% of your earned income annually into your RRSP, until the age of 71 (based on 2024 limits). Participation in an employer pension plan will lower your RRSP deduction limit.
Withdrawals from an RRSP are fully taxable. Withdrawals are not often taken until retirement, although it is possible to withdraw from your RRSP at any time. You are able to defer withdrawals until the age of 71 which allows a significant period of tax deferral. At age 71, you must convert the RRSP to a “Registered Retirement Income Fund” (RRIF) and start to draw down your funds according to prescribed “minimal withdrawal percentages” each year after age 71.
It is important to start saving early and increase your savings rate as you get older to build your savings faster. Let’s see how an RRSP can get you to your retirement savings goal faster:
Benefits of an RRSP
- Tax deductible contributions – The biggest advantage of RRSPs is their tax-deductible nature. RRSPs contributions lower your taxable income and thus reduce your taxes. You get to save for retirement and earn a tax-deduction for doing that, truly a win-win.
- Tax deferred investment growth – You enjoy tax-deferred growth on your RRSPs. That means that as your investments appreciate in value or earn any income (interest / dividends), you do not pay taxes on them until you withdraw them. And, withdrawals are typically in retirement when your tax burden is a lot lower because most people fall in a lower tax bracket then.
- Flexibility to maximize savings – RRSPs make it easy to continue saving, even if you are not the most disciplined with your schedule. If you are unable to make your full contribution one year, it carries forward and you can use that deduction room in the future. However, unlike a TFSA, if you make any withdrawals, those are not added back to your future contribution room.
- Tax benefits through spousal RRSPs– Higher earning spouses can contribute to their spouse’s RRSP provided their contribution is still within their deduction limits, and receive a tax deduction for that year. When it’s time for withdrawal, it is at the lower-income spouse’s tax rate, providing significant tax savings. This feature helps both spouses minimize taxes in the short as well as long term.
- Help for home buyers – An RRSP can also help you get closer to your goal of home ownership. You can withdraw up to $60,000 tax-free from your RRSP to purchase your first home. This feature is called the Home Buyers Plan and combined with TFSA and FHSA, it can help you create significant savings to help buy your first home. You will need to repay the withdrawn amount within 15 years of the withdrawal from your RRSP.
- Upskilling yourself – Thinking of going back to school for a professional degree or certification, or upgrading for your next job? Your RRSP can help with that too! You can withdraw tax free up to $20,000 from your RRSP over four years to fund an eligible education program for yourself or your spouse, under the Lifelong Learning Plan. You will need to repay this amount within 10 years of the withdrawal.
While RRSPs offer attractive tax benefits, you should be aware of their limitations too, so as to optimize their use for your retirement planning:
1. Manage your contributions for tax efficiency – Since you can carry forward your contribution room to future years, take advantage of that flexibility. Capitalize on higher-income years by making larger contributions, maximizing tax deductions when they’re most valuable. In years of lower income, you may not benefit as much from a large tax deduction so consider reducing your contribution and carry it forward to the future.
2. Avoid overaccumulation – An overfunded RRSP can present its own challenges. Excessive growth in your RRSP could create a higher tax liability at withdrawal time in retirement.
3. Keep estate planning goals in mind – Always factor in the impact of RRSPs on your estate. When you pass away, only your spouse can receive your RRSP tax-free. If you have no surviving spouse and your RRSP goes to children (or other beneficiaries), they stand to pay significant taxes on it. The taxes could be as high as 50%, effectively reducing $1,000,000 in your RRSP to $500,000 after taxes.
There are strategies available to optimize taxes on your RRSP. If you would like personalized advice for your unique situation, contact us.
By carefully considering these aspects, you can tailor your RRSP strategy to align with your overall financial goals, maximizing benefits while mitigating potential drawbacks. You are never too young to start saving for retirement. Now that you know about the many advantages of retirement savings through an RRSP, start utilizing it effectively to safeguard your future.