RRSP tax guide

RRSPs are a helpful tool for Canadians to save for retirement. However, there is a catch. RRSPs are subject to unique taxation that users should be mindful of to avoid unexpected tax. To learn more about what tax rules apply to an RRSP, continue reading below.

RRSP taxes

When you make a contribution to an RRSP, you also have the option to invest those funds. If you earn income on an investment within an RRSP, such as interest, capital gains or dividends, these amounts are tax deferred.

In non-registered account, investment is are subject to tax, and you would report capital gains earned when you file your taxes. In an RRSP, you don’t pay tax on the account until you make a withdrawal from it, which will hypothetically occur when you are retired and in a lower income tax bracket.

When you make a withdrawal from your RRSP, that amount must be included on your tax return as income. If you withdraw funds related to investment earnings, this must be reported as income too.

How do RRSPs and TFSAs differ?

The main difference between RRSPs and TFSAs (tax-free savings accounts) is the way they are taxed. RRSPs are subject to taxation whereas TFSAs are not. RRSPs are tax deferred, so tax consequences are delayed until the future, usually retirement. Whenever you make a withdrawal from an RRSP, you must include that amount as income on your tax return in the year the withdrawal was made. You face a tax penalty when you withdraw from your RRSP early, but you can withdraw from your TFSA at any time without needing to report the withdrawal as income and incur taxes on it.

RRSP contribution limit

One limitation of an RRSP is the contribution limit. Unfortunately, you cannot deposit unlimited money into an RRSP. As of 2021, the maximum RRSP contribution limit is 18% of earned income you reported on your tax return in the prior year, up to a maximum limit of $27,830. You can find your current contribution limit by logging into your CRA account or by calling the CRA. If you over-contribute to your RRSP, you will likely face fines. If you don’t use all your contribution room in a particular year, it carries forward to future years.

RRSP tax deduction

In the year you make a contribution to your RRSP, your taxable income will be reduced by the same amount. This is known as an RRSP tax deduction. The RRSP tax deduction is a benefit to you because it defers the tax you pay on income until you make a withdrawal from your RRSP.

Because RRSP tax deductions reduce your taxable income, your tax payable will also be reduced. For this reason, many people contribute to their RRSP as a deliberate way of reducing their tax liability. The taxation year is January 1 to December 31. However, the CRA allows individuals to contribute to their RRSP within 60 days after December 31 and claim that RRSP tax deduction. In other words, if you have excess cash in the 2 months following the tax year end and want to reduce your tax payable, you can make a contribution to your RRSP.

Even though taxpayers use the RRSP tax deduction to reduce their tax payable, you don’t have to wait until the tax deadline to make a contribution. You can make contributions throughout the year until you reach your yearly maximum limit.

Withholding tax on RRSP

Normally, people do not make a withdrawal from their RRSP until they’ve reached retirement. The maximum age limit that you can contribute to your RRSP is 71. However, you may need access to funds from your RRSP before retirement or reaching age 71. This is where withholding tax on RRSPs comes into effect.

Since RRSP withdrawals must be reported as income on your tax return, withholding tax is taken off the RRSP withdrawal as a preemptive way for the CRA to collect taxes. Currently, withholding tax on RRSP withdrawals is set at the following rates:

* Quebec residents also pay provincial sales tax of 16% on top of the federal withholding tax.

Note: If you are a non-resident of Canada and make a withdrawal from your RRSP, you will pay 25% withholding tax, regardless of the withdrawn amount.

When you file your tax return, you will have to report your RRSP withdrawal as income. From there, you may have to pay more tax if the withholding tax didn’t cover the entire tax payable. Your financial institution will provide you with a T4-RRSP. This document shows the amount you withdrew and the withheld tax. The T4-RRSP has all the information you need to report your RRSP withdrawal on your tax return.

Unfortunately, contribution room in an RRSP can’t be gained back once you make a withdrawal. The CRA only lets you meet your contribution limits once, unlike a TFSA where the contribution limit is always available to you regardless of withdrawals.

As a general rule, RRSP withdrawals before retirement should only be considered as a last resort. Otherwise, you will face intense tax consequences and never get your contribution room back.

Is there an RRSP tax refund?

When you contribute to your RRSP, your taxable income is reduced by the amount you contributed. Lower taxable income means lower tax payable. In essence, this is an RRSP tax refund. By contributing the maximum amount to your RRSP you are allowed, you will optimize your tax savings while saving for retirement.

Is there an RRSP tax return?

There is not a specific RRSP tax return. However, line 20800 is where you report your RRSP tax deduction, the amount you contributed to your RRSP in the current tax year.

In addition to reporting the amount on your tax return, you must fill out and attach Schedule 7. This schedule reflects all the activity within your RRSP between March 1 and February 28. If you used the Home Buyers’ Plan or Lifelong Learning Plan, also report that activity on Schedule 7.

Controlling tax brackets

Individuals who are retired or have reached the age of 71 can begin to withdraw from their RRSP without worrying about harsh tax consequences. Because these individuals are normally not working or earning an income, their RRSP withdrawals will be a main source of income. For this reason, you can control the tax bracket you’re in using your RRSP withdrawals. Trying to get into the lowest tax bracket possible is ideal because you’ll pay less tax.

Bottom line

RRSPs are a powerful financial tool available to all Canadians. There are special RRSP taxes to consider, but if you are mindful of them, you can avoid or plan for the tax consequences.

Frequently asked questions

• What tax rules apply to an RRSP?

  Contributions to an RRSP are considered tax deductions that reduce your taxable income accordingly. However, there is a cap on how much you can contribute to your RRSP. On the other hand, withdrawals from an RRSP must be reported as income on your tax return. In addition, withdrawals made before the age of 71 or retirement are subject to withholding tax, which can be as high as 30%.

• How much does RRSP reduce income tax?

  The exact amount depends on the amount of your RRSP contribution, tax bracket and total taxable income. However, RRSP contributions reduce your taxable income by the same amount.