What Is An RRSP?

Every year, in the months leading up to tax season, you likely find yourself inundated with news articles urging you to “Contribute to your RRSP because time is running out!” 

But, as you scroll through Twitter or Instagram, there is no shame if you’ve wondered: “What is an RRSP?” and “Why should I have one?”

A Registered Retirement Savings Plan (RRSP), is a government-supported savings plan aimed at helping Canadians fund their retirement. While retirement is a key focus of this account, there are quite a few other benefits to this kind of account (hint: tax savings and benefits for first-time home buyers).

RRSPs were introduced in 1957 and are registered with the Canadian Federal Government. Since they are part of the Income Tax Act, they are managed by the CRA, which sets the rules around annual contribution limits, the contribution dates, what assets are allowed to be put into a plan and the withdrawal process.

There’s no minimum age for Canadians to open an RRSP and they can contribute to their plan until the year they turn 71, where the RRSP is converted to a Registered Retirement Income Fund (RRIF).

An RRSP can hold different types of assets, such as:

• Cash
  
• Bonds
  
• Guaranteed Income Certificates (GICs)
  
• Mutual funds (that are RRSP eligible)
  
• Exchange-traded funds (ETFs)
  
• Equities (Both Canadian and foreign stocks)
  
•  Transfers from banks, trust companies or credit unions
  
• Gold and silver bars
  
• Canadian mortgages
  
• Mortgage-backed securities
  
• Treasury bills
  
• Income  trusts

RRSPs are available at most banks, credit unions, life insurance companies, mutual fund companies and investment firms.

Why You Might Open an RRSP

Apart from saving for retirement, there are other benefits to having an RRSP. The first is a tax deduction. When you contribute to an RRSP, you get a deduction, which reduces your taxable income when you file your taxes. If that puts you in a lower tax bracket, you will pay less tax or get a tax refund you can use toward any other financial priority.

The second benefit is that the money grows tax-free in your RRSP. All capital gains, interest income and dividends aren’t taxed, as long as the money remains in the account.

That being said, when you withdraw from your RRSP, you’ll have to pay taxes on it. But Ideally, when you absolutely have to withdraw the funds from your RRSP at the end of the year you turn 71. Since you’ll ideally be well into retirement by then, your marginal tax rate will be lower and you’ll pay less tax.

How does an RRSP Work?

We’ve talked about what an RRSP is, where you can open one and what can be held in it, but how does it actually work?

As mentioned before, having an RRSP lets you save for retirement while providing a tax deduction. There are some guidelines around how much you can contribute on a yearly basis, your deduction limit and how much you can withdraw without penalty before the end of your 71st year when you  have to withdraw from the plan.

Contribution Guidelines

Each year, you earn contribution room in your RRSP. If you don’t use it all, it carries forward to the next year. Your yearly contributions and how they’re invested all play a role in how much room you can accumulate.

As soon as an RRSP owner starts working, they start building what’s known as either contribution room or a deduction limit. That’s the amount you can deposit in your RRSP every year without penalty. For tax year 2023, ​the deduction limit is 18% of the earned income you reported the previous year up to $30,780–up from $29,210 in 2022.

You can make RRSP contributions in the form of lump sums at specific times throughout the year. This option is popular from December to March as people look for ways to reduce their taxable income before the RRSP contribution deadline of late February/early March and before the tax filing deadline of April 30. (February 29, 2024, is the last day to make RRSP contributions for the 2023 tax year.) Another option is to make regular contributions throughout the year via pre-authorized deposits.

How Much Can I Contribute to an RRSP?

Each year, your contribution room will be whichever of these two amounts is less: the equivalent of 18% of your earned income as reported on your previous year’s tax return, or the annual limit of to a maximum of $30,780 for 2023. 

Plus, any unused contribution room from previous years and minus any pension adjustments if you have a pension. If you don’t contribute the max in a given year, that amount is carried forward indefinitely.

How do the RRSP contribution carry forward rules work?

If you’ve been working for a few years and you haven’t contributed your maximum every year, you have “contribution room” to spare. Let’s say you have $20,000 in room in your plan. You’ve put in $15,000 in your RRSP for the year and your annual income is $100,000.

Your 2023 contribution limit would be: ($100,000 x 0.18)+($20,000-$15,000) = $23,000, which is less than $30,780.

If you’ve put in $23,000, the CRA will treat you as if your annual income is lower than $100,000.

Thankfully, you don’t have to do math to figure out your contribution room. You will get a notice of assessment which will let you know or you can create an individual account on the CRA website and discover your annual limit for yourself. 

Spousal RRSPs and How They Work

Most of us are familiar with individual RRSPs but a Spousal RRSP is a version for married or common-law couples where the higher-income-earning spouse can open a spousal plan for their partner and contribute to it.

With a spousal RRSP, the lower-income-earning partner owns the plan, so  they’re the only ones who can make investment decisions and withdraw from the plan – the other partner contributes to it and that’s it.

Like an individual plan, a spousal RRSP can automatically convert to a RRIF at the end of the year the owning spouse turns 71 or they can convert early after age 65. They can also withdraw from the plan using the RRIF or receive all the money as a lump sum, but either way they  will pay taxes on any withdrawals  based on their income bracket, just like an individual plan.

Opening two spousal RRSPs (one for each partner) allows couples to split their income after they retire. The contributing spouse gets a tax deduction and the owning spouse will be taxed at a lower marginal tax rate on withdrawal, which lowers the couple’s joint tax bill.

Other Types of RRSPs

Besides individual and spousal RRSP, there are other types of RRSPs you may want to look into depending on your options and preferences:

• Self-directed RRSP – A plan where you control what your RRSP is invested in while your financial institution assists with the administration, including getting the plan registered, receiving your contributions and trading securities.
• Group RRSP – An employer-sponsored plan where employees can make small contributions to their RRSPs through payroll deductions. Often, an employer may match their employees’ contributions. Both contributions from your employer and yourself as the employee, give you a tax deduction as the plan holder while your investment still grows on a tax-sheltered basis.

How Much Should You Contribute to an RRSP Each Year?

Overall, you should contribute the maximum to your RRSP each year to get the full tax deduction benefits. If you can’t max it out, but still want to contribute to an RRSP, then put in as much as you can. 

If you’re wondering how much that is, the general recommendation is to start with 10% of your income as a contribution and increase that amount as your income rises.

Can you over-contribute to RRSPs? 

If you over-contribute to an RRSP, you have a buffer of up to $2,000. Above that, you have to pay 1% per month unless you withdraw the excess funds before the end of the month you contributed or you’re contributing to a group RRSP sponsored by your employer.

To fix this, you have to file a Tax Year Individual Tax Return for RRSP, PRPP, and SPP Excess Contributions (T1-OVP), within 90 days following the end of the tax year.

Even with a solution for over-contributions, contributing to an RRSP is not the best option for everyone.

First, if your tax bracket is low, to begin with, the tax deduction that comes from contributing to your RRSP won’t offer much in terms of savings. Plus, if your tax bracket is expected to be the same or higher when you retire, you’ll end up paying the same amount of tax (or more) than you do now when the funds are withdrawn. But there are ways you can defer paying tax on RRSP withdrawals.

How Can I Withdraw From an RRSP Without Paying Tax?

There are situations where you can withdraw from your RRSP and defer paying taxes on the withdrawal, but these circumstances have specific requirements:

• The Home Buyers Plan – This is a tax and interest-free loan of up to $35,000 that first-time homebuyers can use towards a down payment or to build a qualifying home for themselves or relative with a disability. The one caveat is it does have to be repaid over 15 years.
• The Lifelong Learning Plan – Withdraw up to $10,000 in a calendar year and $20,000 total towards education for you and your partner. You have up to 10 years to repay it.

If you don’t qualify for one of the above tax-free plans, you will pay tax penalties on your RRSP withdrawals. 

When you withdraw money early, your financial institution will withhold the tax and remit it to the government. According to the Government of Canada, the penalties are:

• 10% (5% in Quebec) on amounts up to $5,000
  
• 20% (10% in Quebec) on amounts over $5,000 up to including $15,000
  
• 30% (15% in Quebec) on amounts over $15,000
  

If you find yourself paying penalties for early withdrawals or constantly getting dinged for overcontributions, then you may want to open a registered plan where you pay no tax up to an annual limit, like a TFSA. Of course, this leads to an obvious question.

What’s better, a RRSP or TFSA?

The short answer is, it depends on your short and long-term financial situation, but here are some things to consider when deciding between the two:

Bottom Line

An RRSP isn’t the sexiest financial product out there but it is a powerful tool that not only helps you save for retirement but provides tax deductions and deferrals that Canadians can use as part of their long-term financial plan.