Chances are, if you haven’t used a registered retirement savings plan (or RRSP for short) you know someone who has. That’s because the RRSP is a staple of Canadian savings, and it has been since its inception in 1957. It’s almost become the norm now for people to save money in RRSPs. You often hear about people making contributions themselves at the bank, through their employers, making the RRSP deadline, or maxing out their RRSPs.
What do any of these statements mean, and how are they significant? Are RRSPs even as good as they appear to be? To get the answer to these questions, we have to understand a bit of the technicalities of RRSPs. This is exactly what we’re going to do today. Here are 7 facts about RRSP that you need to know.
An RRSP is a type of registered account which was created by the government as a way to encourage people to save for their own retirement. As an incentive, it provides special tax benefits which we go into later in the article.
You can open up an RRSP account at almost any financial institution such as banks, investment firms, and insurance companies. Another decision you’ll have to make is what sort of investment you want to put into your RRSP. It can simply be a savings account or a GIC. You can also invest in stocks, mutual funds, plus many other options. Regardless of the investment, you’ll receive the same tax benefits simply because the investment is held within an RRSP account.
How your contribution room is calculated is done by taking earned income (which means working income or self-employed income. Note that this excludes investment income or dividend income. For the difference in income types and how they’re taxed, please take a look at our article here.) and then calculating 18% of that, resulting in your total contribution room for that year.
As an example, someone who made $50,000 in working income in 2017, would have a contribution room of $50,000 x 18% = $9,000
The idea is that if someone makes quite a bit of money, they can’t have nearly unlimited contribution room!
If you don’t use your contribution room this year, you don’t miss out on anything because it just gets added on to your total, lifetime contribution amount! You can always use that room next year. In some extreme cases, there are people who have hundreds of thousands of contribution room in their RRSP just because they’ve never contributed to it their entire lives.
This is one of the main reasons why people love the RRSP. Any contribution you make is tax deductible. Using the previous $50,000 income earner example, if they made a $5,000 contribution, they would only have a taxable income of $45,000. This can make a big difference on their taxes, as they effectively save taxes on $5,000 worth of income, which would be roughly $1,500 of real dollars!
Typically, when you have a regular investment, you are taxed at the end of every year. With a tax-sheltered investment such as the RRSP, you don’t actually get taxed on any growth until you decided to withdraw the money. At that time, you would pay taxes on whatever you choose to withdraw. The idea is that when you’re retired, you are typically earning less money, which means the income you take from your account will be taxed at a lower rate.
A note here that if you have good planning for retirement with steady income streams, it’s possible for you to actually be earning just as much in retirement as you were while working! As a result, some people run into an issue of not wanting to withdrawal money from their RRSP for fear of massive tax repercussions.
If the money sits in an RRSP perpetually, the government will never be able to tax it. That’s why there is a rule in place which converts your RRSP to a RRIF. The main function of the RRIF is that you are forced to withdrawal the money at a pre-determined rate set by the government. By age 90, all the money will be withdrawn and as you may have already guessed, all the withdrawals are fully taxable.
The only 2 things we can’t escape in life: Death and taxes
Now that you’re armed with this knowledge about RRSP, we encourage you to read about any other savings and investment vehicles you might want to use to put together the best financial plan for yourself!
FlexFi Inc. is not a financial advisory firm.
This article is for informational purposes only and is not a substitute for individualized professional advice.
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