If you’re still young (or young at heart), you might not be thinking about saving money for your retirement quite yet. That said, it’s never too early to start putting cash aside. If you’re looking to get the ball rolling, one of the only ways to save for retirement in Canada is to open a Registered Retirement Savings Plan (RRSP).
Find out more about how these retirement savings accounts work and learn more about how you stand to benefit from putting money into this type of account.
One of the only ways to save for retirement in Canada is to register for a Registered Retirement Savings Plan (RRSP). This is a government-issued savings and investment vehicle that lets you put money away for your future.
Any interest you earn on your contributions will be tax-free up until the point that you withdraw your money. You’ll also be able to deduct the money you put in each year from your taxes, which could put you into a lower income bracket and give you a higher return.
How does max contribution room work?
Anyone who files an income tax return in Canada can open and contribute to an RRSP. Every year, the Canadian government sets limits for how much you’re allowed to invest based on your income. For example, in 2020, you can contribute up to 18% of the income you earned in the previous year (or up to $27,230). You can also carry forward any unused amount if you haven’t made contributions in previous years.
You can find out how much room you have by looking at your Notice of Assessment from the previous year. It’s also possible to access the amount you’re eligible to contribute by signing into your CRA MyAccount.
Types of RRSPs in Canada
There are four main types of RRSPs that you can hold in Canada, depending on what type of holdings you keep in your account. Aside from these accounts, you can also choose to hold your RRSPs as individual, spousal or group accounts, depending on your preferences.
These RRSPs function just like any other savings account, except you’ll be taxed at a high rate if you take money out before you’re set to retire. You’ll typically earn a fixed interest rate that won’t fluctuate based on market conditions for any savings you put in.
GIC RRSPs can help to balance out risk in your portfolio by holding your money in guaranteed investment certificates (or GICs). With these RRSPs, you’ll earn a fixed or fluctuating interest rate on any amount you put in, but you won’t risk losing any of your principal investment. The only downfall to this type of RRSP is that you won’t be able to access your funds before your GIC matures.
These RRSPs let you hold your money in RRSP-eligible market products such as stocks, bonds, mutual funds and mortgage-backed securities. These RRSPs typically offer fluctuating interest rates and are often higher-risk investments than holding cash or GICs in your account. This is because you can lose your principal investment if the market doesn’t perform well.
While most RRSPs are managed by your financial institution or investment firm, you can also choose to manage your portfolio on your own. This will let you purchase stocks, bonds and mutual funds at your leisure. Before you choose to go this route, you should make sure you have the time and expertise to be able to monitor your investments and change directions when your portfolio isn’t performing well.
Ways to save within a retirement account
Retirement accounts act as a home for your retirement savings, allowing you to place investments and other deposit accounts inside. Once you’ve decided to open a retirement account, you’ll need to think about which products you’ll use to reach your goals:
You can hold cash in your RRSP just as you would with a savings account. This cash will typically earn a flat or fluctuating rate of interest. It’s a less risky investment than holding stocks, bonds or other market-linked products in your account, but it will typically pay lower returns as well.
Stocks are shares that you own in a particular company. When the company does well, the price of your stocks will increase and you’ll be able to sell your shares for more than you paid for them. You may also make dividends on your stocks, which are typically quarterly payments that give you a share of the company’s revenue.
Bonds are loans that you make to a company or government so that it has the money it needs to operate. In return, it will pay interest on the money it borrows which will help to build up your RRSPs. Bonds eventually mature after several years and at this point, the principal amount you loaned out will be paid back to you as well.
Guaranteed investment certificates (GICs)
GICs are a safe and secure investment that offer you a guaranteed return on your principal. Your funds will typically be locked into your GIC for a certain amount of time, and you’ll earn a fixed rate of interest on your investment. These investments can be used to balance out your RRSP so that a portion of your money is protected even if you decide to put some of your funds into higher-risk stocks and bonds.
Mutual funds are a shared investment vehicle that allow you to pool your money with other people to invest in a variety of stocks, bonds or other securities. These are particularly useful when you’re a small investor, since you’ll get a much wider mix of investments than you would likely be able to afford on your own. You can also get exchange-traded funds or index funds, which are similar to mutual funds except they’re listed on exchanges and let you trade shares throughout the day just like ordinary stocks.
Mortgage-backed securities are fixed-rate investments that let you buy into a pool of mortgages that are being paid back to the bank. Every month, you’ll get a proportional share of the interest and principal payments associated with those mortgages. This money will be deposited directly into your RRSP so that your funds will increase as the mortgages in your holding are paid back.
Gold and silver
Gold and silver are the only two types of precious metals that can be held in RRSPs. The benefit of these commodities is that when the stock market goes down the price of gold and silver goes up. These investments will still qualify for the tax benefits you get with your regular account.
Compare retirement savings accounts
Comparing retirement savings accounts is similar to comparing regular bank accounts. Here are a few factors you should consider:
Competitive interest rate
Competitive interest rate
You should look for the most competitive interest rate on your RRSP if you hold cash in your account. You should also look for the stocks, bonds and mutual funds that have a decent performance history and promise to give you the best return on investment.
To make sure you don’t have to pay out-of-pocket expenses, you should look into an RRSP that charges minimal fees. You might need to pay a small set-up fee with any account, but you’ll want to ask your institution about regular fees like account maintenance fees that could eat into your profits.
Given the popularity of online banking, your bank should allow you to access your retirement savings account online or via a mobile banking app. This will let you track your spending and monitor the performance of your funds on the go. If you have a self-directed RRSP, this will also let you trade and manage your investments quickly and easily from the comfort of your own home.
Consider how much risk you’re willing to take on when choosing an account. If you invest in cash or GICs, your funds will be much more secure than if you invest in a high-risk portfolio. The best way to get the best return on your RRSP is to mix and match the types of holdings you have so that you have stability in your portfolio while still earning a high return on your market-linked investments.
Each type of retirement savings account is funded differently, so it’s important to think about how you’re going to make contributions. You’ll need to consider whether you’re going to open your account alone or through your employer and if you’re going to fund your account with pre- or post-tax income.
Pros and cons of using a retirement savings account
Retirement savings. You’ll earn higher returns compared to conventional bank accounts. You can also choose how much and how often you’d like to contribute, allowing you to tailor your strategy to your retirement goals.
Tax advantages. Depending on which type of account you open, retirement savings accounts provide tax benefits that can reduce your taxable income and save you money on your tax return.
Flexibility. You can hold many types of investments in your retirement savings account, which allows you to balance your high-risk investments with guaranteed investments. This will make sure that you’re protected even if the market goes down.
No fees. Most RRSPs don’t cost anything to open and there are many options that won’t charge you monthly fees to maintain your account.
Special protections. If you put your money into an RRSP GIC, you’ll be protected by the Canada Deposit Insurance Corporation for up to $100,000.
Contribution limits. You’ll only be able to contribute 18% of your income to your account each year, and you’ll have to pay fees to the government if you over-contribute.
Limited growth. Returns are generally limited to low interest rates, compared to investments and other retirement accounts that may have a higher potential for growth.
Restricted access. You won’t be able to make withdrawals whenever you need money with most retirement savings plans because they’re locked in and are taxed heavily if you withdraw funds before you’re eligible to do so.
Taxable upon withdrawal. Even though contributions may be tax-deferred or tax deductible, your withdrawals will be subject to income tax once you start pulling a pension from your account.
Minimum distributions. Some accounts require you to start making withdrawals once you reach a certain age, even if you’d rather let your money grow in your account.
Tips for using a retirement savings account
Just like any other type of deposit account, there are a few things to watch out for before opening a retirement savings account:
Read the terms and conditions
Make sure you go through the terms and conditions or product disclosure documents before signing up for any retirement savings account. The summary page should give you a clear indication of any applicable service fees and charges.
Understand your options
Each retirement savings account is different from the next. It’s important that you understand what types of investments you can hold in your account and how each one can help to balance out the risk in your portfolio.
Learn about taxes and penalties
Find out how much you’re eligible to contribute each year and learn how much you’ll have to pay to make withdrawals. You should also consider how much you want to save on your income tax and make your investments strategically at tax time.
Speak with a financial advisor
While RRSPs and other retirement savings accounts are typically more straightforward than other investment vehicles, it never hurts to get some guidance about where you should put your money. Consider speaking with a financial advisor to determine which account is right for your financial goals and get some tips on how you can get started on saving.
Retirement savings accounts can save you money at tax time and they’re a good way to start saving for your future. You can hold both low- and high-risk investments in these accounts, and it’s easy to open an account online or with your bank. Just be aware that you’ll be taxed heavily if you take money out of these accounts before you turn 65 years old. Learn more about RRSPs here.
Frequently asked questions
Yes. You won’t be taxed if you take money out of your retirement savings account to buy your first home or to pay for post-secondary education or training. The only caveat is that any money you take out has to be put back into your account within a specific time frame.
You’ll have to start drawing money out at the age of 71, but you can start taking money out at 65 years old if you need to supplement your income. The best way to do this is to convert your retirement savings plan into a registered retirement income fund (RRIF), which enables you to earn a regular monthly payment from your savings.
Yes. Many Canadians choose to save for retirement using a tax-free savings account (TFSA). This works in much the same way as an RRSP, except you can take money out whenever you want.
Claire Horwood is a writer at Finder, specializing in credit cards, loans and other financial products. She has a Bachelor of Arts in Gender Studies from the University of Victoria, along with an Associate's Degree in Science from Camosun College. Much of Claire's coursework has focused on writing and statistics, with a healthy dose of social and cultural analysis mixed in for good measure. She has also worked extensively in the field of "Blended Finance" with the Canadian government. In her spare time, Claire loves rock climbing, travelling and drinking inordinate amounts of coffee.
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