Having a Registered Retirement Savings Plan (RRSP) is important and it is amongst the essential savings accounts that every Canadian should have like the Tax-Free Savings Account (TFSA). An RRSP is beneficial to you in the long run as you will have an accumulation of savings to use for your retirement, but the RRSP can help you deduct your taxable income as well. There is a growing number of Canadians who are more aware of the importance of having savings accumulated for retirement. The RRSP can be a great way to ensure you have savings that will last you in the long term. You also have the option to use your RRSP to make investments from stocks to your first home purchase. In this blog we will discuss all of the features of the RRSP, why you should have an RRSP, the pros and cons, how you can use your RRSP before retirement and after retirement, the types of RRSPs and much more.
What is a Registered Retirement Savings Plan (RRSP)?
A Registered Retirement Savings Plan (RRSP) is a tax-advantaged retirement savings plan that is established by you and is registered by the government. Ideally, you should contribute to the RRSP throughout your life and once you retire, you convert it to a Registered Retirement Income Fund, then purchase an annuity or make a lump-sum withdrawal to access your savings. You can also make withdrawals from your RRSP to use towards purchasing your first home or for education. The RRSP is a great way to lower your taxes now, while also saving your money for your future retirement plans. You can contribute to this account until you are 71 years of age and withdraw the money and transfer it into a Registered Retirement Income Fund (RRIF) as early as 55 years old.
How a Registered Retirement Savings Plan (RRSP) works
The way that a Registered Retirement Savings Plan (RRSP) works is simple enough. Once you open an RRSP account, you can decide to use it for just saving up cash, or you can save and combine it with an investment vehicle (GICs, ETFs, bonds, stocks, and mutual funds) to earn income on your savings account. Ideally, you want to make recurring contributions to your RRSP which is beneficial to your investments because they are tax-deferred until they are withdrawn. The contributions that you make to your RRSP are tax-deductible, meaning that your contributions can be deducted from your total income when you file your income tax every year or you can carry it over to the next year’s tax season if you expect a larger income. After years of savings, you must stop contributing to your RRSP on the year of the year that you turn 71 years old. You can then convert your RRSP into a Registered Retirement Income Fund (RRIF), purchase an annuity, or withdraw your savings as a lump-sum to receive your savings. Receiving your savings will be considered taxable income, but your tax rate will be less since you will most likely be earning less income when retired.
You can also access money from your RRSP if you are planning to go back to school and get an education with the Lifelong Learning Plan. You can also access some money from your RRSP if you are purchasing your first home with the Home Buyers’ Plan.
Pros of having a Registered Retirement Savings Plan (RRSP)
Tax-deferred, and tax free investment growth
Reduce your income tax with contributions to your RRSP
RRSP is safeguarded from creditors
Use your RRSP savings for your first home purchase
Use your RRSP savings to pursue your education
Withdrawals can be made anytime in the case of emergency
Cons of having a Registered Retirement Savings Plan (RRSP)
Contribution room is limited based on how much income you earn
Withdrawals are taxed heavily
Home Buyer’s Plan and Lifelong Learning Plan funds must be returned or you risk getting penalized
RRSP savings may affect eligibility for federal benefits
Withdrawals before maturity can be taxable, and can risk compounded interest
Why you should have a Registered Retirement Savings Plan (RRSP)
The main reason why you should have an RRSP account is to save for your retirement. Retirement is a tough time for many Canadians if they are not financially equipped to afford not working. Many Canadians find it more difficult than they originally expected when trying to afford the living expenses as a retiree. Below are just some of the reasons why you need to be more conscious of your retirement planning and why you should have a RRSP.
How much should you have saved up for retirement
Even with a pension plan, the funds are simply not enough to compensate for all expenses to live a comfortable retirement. Some studies have shown that Canadians should expect to spend approximately 70-80% of their pre-retirement amount when they retire. This is a lot of money, but it is a realistic estimate and you should prepare for your retirement as soon as possible.
Invest your contributions for growth
With an RRSP you can save throughout the years, and can use the RRSP as a vehicle to drive income on your savings through tax-deferred investments. Savings can be made weekly, bi-weekly, or monthly to compound the investment.
Take advantage of the contribution limits/deadline
The yearly contribution limit is usually 18% of your total annual income up to a certain maximum (for 2022 the maximum was $29,210). This amount has a deadline each year, which is typically in the beginning of March. For 2022, the deadline is March 1st, 2022. This deadline means that any contributions made to your RRSP until March 1st, 2022 can be filed in your 2021 income tax return. With this being said, you are encouraged to reach your contribution limits every year if that is possible. It is very important to try to reach your limits because of the fact that contributions towards your RRSP will be deducted from the taxable amount on your income tax return.
Pay less and claim less on your income tax
Contributions made to your RRSP will be deducted from your income when you file your tax return. Ultimately, you can reduce the taxable amount of income on your tax return by 18% which is a dramatic amount. This is one of the most unique parts about the RRSP which makes it extremely attractive compared to non-registered retirement savings accounts. You are basically saving both for your future retirement plans, and you are reducing the taxes you might be charged currently, therefore it is a win-win situation.
How you can use your Registered Retirement Savings Plan (RRSP)
There are a couple of ways that people can use their RRSP when they retire and before they retire. Prior to retirement you can use your RRSP for purchasing your first home with the Home Buyers’ Plan, or to go to school with the Lifelong Learners Plan. When you retire you can transfer your money into a Registered Retirement Income Fund (RRIF), an annuity, or take the money out in a lump-sum.
Lifelong Learners Plan
You can use your RRSP if you are looking to get an education or for training with the Lifelong Learners Plan which will allow you to make a withdrawal from your RRSP for educational purposes. This plan allows you to withdraw $10,000 per year up to a maximum of $20,000. This plan will require you to return the money you withdrew, back into your RRSP within 10 years of withdrawing it. It roughly equals out to paying one-tenth of the total amount withdrawn each year. You should also create a repayment schedule and plan with your bank to make sure that you aren’t missing out on payments, but more importantly if you do not return the money that you withdrew, it will be considered income. For example: if you need to repay $3,500 but only repaid $2,000 that year, then the government will consider the remaining $1,500 as income and you will need to pay income tax on that amount.
Home Buyers’ Plan
The Home Buyers’ Plan (HBP) is another awesome way to use your RRSP before your retirement. This plan allows you to borrow up to $35,000 tax-free to use for a down payment towards purchasing a house. This is a great way to bump up your down payment dramatically and it is even better if your partner has an RRSP. Your partner (if they are also a first time home buyer) can also borrow up to $35,000 tax free from their RRSP for the down payment as well, this is a combined total of $70,000 tax free! You must make repayments and return the money that you borrowed within 15 years of withdrawing it.
How to enroll in to the Home Buyers’ Plan
The Home Buyers’ Plan works as long as the amount you plan on withdrawing is in your account 90 days prior to withdrawing it. You then need to fill out the T1036 Form from the Canada Revenue Agency and coordinate the withdrawal with your bank. These forms will be referenced when you file your taxes the year you withdraw the amount. You must also make sure that you withdraw the amount within 30 days of taking on the title of a home, if you exceed this timeframe you will not be eligible for the HBP.
Home Buyers’ Plan eligibility requirements:
- RRSP fund that you are borrowing must be in the account 90 days prior to withdrawal
- You cannot have owned a home in the last 4 years
- You have entered into a agreement to buy or build a qualifying home
- You intend to primarily reside in the home you are purchasing within 1 year of purchase
- Must make the withdrawal within 30 days of taking on the title of the home purchase
- Must be a Canadian resident
- Must not have owned a in the last 4 years, and if you have taken part in the HBP previous you must not have an outstanding balance on the repayment
Home Buyers’ Plan repayment
- You must repay the borrowed amount within 15 years of withdrawing it
- The first repayment amount must be paid in the first 2 years after withdrawal
- If a repayment is not made or missed, then the repayment amount that was miss will be considered taxable income that year
- To find out how much you owe in instalments:
- For example let’s say you borrowed $35,000 and want to pay it back in 15 years. The total RRSP withdrawal amount is $35,000, so divide $35,000 ÷ 15 year = $2,333 annual payment.
- Now take the annual payment and divide it by 12 months: $2,333 ÷ 12 months = $194.41/month
Registered Retirement Income Fund (RRIF)
A Registered Retirement Income Fund (RRIF) is a retirement fund that pays out income to you when you become a retiree and start using your Registered Retirement Savings Plan money, and is a product of when you convert your RRSP. Rolling over (converting) your RRSP to a RRIF will not result in taxation but the income payouts is considered taxable income. The basic purpose of an RRIF is to have consistent payouts to retirees so that they can enjoy using their RRSP savings for their retirement expenses.
How to open a Registered Retirement Income Fund (RRIF)
To open a Registered Retirement Income Fund (RRIF) you can go to a financial institute such as a bank, a credit union, a trust, or an insurance company, you are also available to open more than one RRIF.
Registered Retirement Income Fund (RRIF) minimum withdrawals
When getting payouts from your RRIF, your withdrawals are based on a minimum yearly amount. This amount is calculated by basing it off of your age at the beginning of each year, you can also calculate your minimum amount based on your partner’s age, once you make your decision it is final.
When the holder of a Registered Retirement Income Fund (RRIF) passes away
When the original holder of an RRIF passes, there can be a beneficiary assigned and the remaining funds can be transferred directly to the beneficiary’s RRSP, RRIF or a new annuity.
An annuity is similar to an RRIF, but is not registered with the government. This has a couple other differences compared to an RRIF but not too many. An annuity can be opened with a financial institution and the annuity will outline the dates you will receive the consistent payments, and the amount you will receive. The annuity works when you transfer a lump-sum amount, typically from your RRSP, to a financial institution, they will then invest the amount, and provide you with consistent payments in scheduled intervals and additional possible income.
RRSP lump-sum withdrawal
You can also withdraw a lump-sum amount of your entire RRSP savings but this will result in immediate taxation when you withdraw the lump-sum, and you will be required to claim the amount as income when you file your tax return.