Registered Retirement Savings Plans (RRSP) in Canada

It’s never too early or too late to start planning for retirement. For residents of Canada, the Registered Retirement Savings Plan (RRSP) offers a holistic approach to retirement planning with plenty of tax benefits and flexibility to boot. With an RRSP, you get defined contribution limits, carry forward amounts that accumulate each year and the ability to make pre-retirement withdrawals on important purchases like education and your first home.

Whether you are nearing retirement or just starting your career, here is everything you need to know about Registered Retirement Savings Plans (RRSP) in Canada.

What is an RRSP?

An RRSP is a retirement savings and investment vehicle for Canadian workers and self-employed business owners. Contributions made into the fund grow tax free until withdrawal, at which time the normal marginal tax rates apply. With an RRSP, workers can defer income tax from their highest earning years to retirement when their income and tax liabilities are lower.

Although RRSPs can be structured differently based on your investment goals, all entail the same basic formula: a worker puts a portion of their income into the fund on an ongoing basis without exceeding the contribution limit set forth by the Canadian Income Tax Act. Generally, “contributions” entail purchasing financial securities like mutual funds, exchange-traded funds, bonds or other types of securities.

Benefits of using an RRSP

The benefits of using an RRSP include the following:

• Tax benefits: Workers contributing to an RRSP may deduct contributions against their income; the investments growing inside the fund are also sheltered from taxes.
• Large contribution space: Although the maximum contribution limit for an RRSP as of 2019 is 18% of earned income up to a maximum of $26,500, any unused space is carried over to subsequent years, which means you never lose unused contribution space.

The disadvantages of using an RRSP include the following:

• Lack of liquidity: Withdrawing money out of an RRSP before retirement carries hefty penalties, not to mention tax liabilities.
• Tax complications during retirement: By age 71, Canadians must have converted their RRSP to a Registered Retirement Income Fund to start withdrawing income, but some may not be prepared for the tax burden that their income generates; this may impact other retirement benefits, such as Old Age Security.

Types of RRSPs

• Individual RRSP. Established by a single person who acts as both the main contributor and account holder.
• Group RRSP. Established by a company for its workers with contributions deducted from their pay cheques.
• Spousal RRSP. Benefits are provided for a single spouse, though both spouses also receive a tax benefit. For example, a high-earning spouse may contribute to a Spousal RRSP in their spouse’s name.
• Pooled RRSP. A retirement vehicle created for small business workers and employers, as well as for the self-employed.

How to set up an RRSP

You can set up an RRSP by visiting a financial institution, such as a bank, credit union, trust or insurance company. They will advise on whether you meet the criteria for opening up an RRSP and can help you decide how to invest your savings. The best approach is to schedule a meeting with a financial advisor at one of these institutions.

If you don’t have an account with the financial institution, bring two pieces of identification when you go to set up your RRSP account. From there, you will be asked to complete an RRSP application that outlines your investment knowledge, goals and financial information. Once your RRSP is open, you can contribute right away or transfer money from another account.

Interest rates: How much can I earn?

The interest rate earned on an RRSP depends on the type of investment you’ve selected and how that investment performs over time. For example, GICs are considered low-risk and often pay anywhere around 0.10%-2% annually in interest, depending on the length of the term – shorter terms yield lower rates, while longer terms yield higher rates. You can generally make more from bonds, though the yield is still relatively conservative at around 2%-4.5% annually.

On the other hand, a balanced mutual fund (mix of both stocks and bonds) is considered low-medium risk and therefore pays more. Funds often return an average of 4%-7.5% annually in the long run, though rates can fluctuate from year to year.

Besides the rate of return, you should also consider the impact that fees and MERs (management expense ratios) will have on your savings. An investment with a more conservative interest rate and low fees may yield more than a stronger-performing investment that comes with higher fees.

How to contribute to an RRSP

One of the benefits of having an RRSP account is you can contribute anytime. To be eligible for tax deductions, you must make contributions during that tax year or up to 60 days into the following year.

As of 2019, the maximum contribution limit for an RRSP is 18% of earned income up to $26,500. The maximum contribution is lower if you participate in an employer-sponsored pension plan. Nevertheless, unused contribution space is carried over to subsequent years, so you never lose unused contribution space. For example, if your contribution limit in $20,000 but you invest only $15,000, the $5,000 you didn’t contribute is carried over into the following year.

How to make withdrawals from an RRSP

While an RRSP is a great investment tool, in most cases, pre-retirement withdrawals are subject to stiff penalties. Any withdrawal is immediately subject to a withholding tax proportional to how much you took out. If you withdraw up to $5,000, the withholding tax rate is 10%; withdrawals of between $5,001 and $15,000 are subject to a 20% tax rate, and if you take out more than $15,000, the withholding tax spikes to 30%. These rates apply everywhere in Canada except Quebec, where provincial tax rates are included on top of the federal withholding tax.

RRSP withdrawals are classified as income, so marginal tax rates also apply. If your marginal tax rate is higher than the withholding rate, expect to pay additional tax at the end of the year.

However, there are 2 situations in which you can withdraw from an RRSP without being taxed:

• Under the Home Buyers’ Plan (HBP), you can take up to a certain amount out of your RRSP to buy or build a qualifying home for yourself or a related person with a disability. Your home must be located in Canada, and you cannot merely be renting. In 2019, the government set the withdrawal limit under this plan at $35,000.
• Under the Lifelong Learning Plan (LLP), you can take up to a certain amount out of your RRSP to pay for full-time training or education for yourself, your spouse or your common-law partner. Withdrawals cannot be used to cover training or educational expenses for your children or your spouse/common-law partner’s children. As of 2019, the maximum yearly withdrawal limit is $10,000 up to a total limit of $20,000 (once you reach this, you’ll have to wait a while to withdraw again).

Frequently asked questions about Registered Retirement Savings Plans

• Are there any exemptions to the withdrawal penalty?

  Yes, you may withdraw up to $25,000 from your RRSP tax-free for the purpose of purchasing your first home. If you want to study, you may also be able to take out $20,000 tax-free to pay for your education. However, you cannot withdraw more than $10,000 in one year. In either case, you need to repay the money in full within 15 years.

• What happens to my RRSP when I retire?

  Investments into your RRSP can remain in the fund until you are 71 regardless of your employment status. At that age, you will be required to start withdrawing the money. The most popular option is converting your RRSP into a Registered Retirement Income Fund (RRIF), which enables you to earn regular monthly retirement income.

• What's the main difference between an RRSP and a Registered Pension Plan (RPP)?

  Whereas an RRSP is an individual retirement plan, an RPP is an employer-directed pension plan. Although both have the same goal of providing retirement income, an RPP is established by companies to provide pensions to their workers.