Canadians are living longer and longer, and for many, saving for retirement is essential. That’s why the Canadian Government created the RRSP to empower Canadians to build their retirement nest eggs and receive yearly tax rebates for doing so. Your RRSP’s contribution limit is determined by 18% of your prior year’s reported income up to a defined contribution limit indexed to the annual increase in the average wage. Most types of investments can be held in an RRSP, including stocks, bonds, exchange-traded funds and mutual funds. You should always check with your financial institution, dealer or portfolio manager before investing in RRSP to make sure these investments are RRSP eligible.
Advantages of an RRSP
Contributions made to your RRSP in your working years are deducted from your taxable income and, if invested, can grow tax-free while the funds stay in the account. Once in retirement, withdrawals from your RRSP will be taxed at your retirement income bracket, which should be less than in your working years. If your contributions are invested, an RRSP can help you grow your investments over time without the tax drag on your returns as you would experience in a non-registered investment account. An RRSP also allows Canadians to utilize their contributions to the account for the following:
Lifelong Learning Plan (LLP)
RRSP also offers the unique benefit of helping you further you or your spouse’s education. The Lifelong Learning Plan (LLP) allows you to withdraw from your RRSP to pay for training or a full-time education for you or your spouse. The withdrawal is not taxable but the funds must be paid back into the RRSP over ten years, typically starting five years after the first withdrawal. Any funds not paid back in the ten years period are permanently lost from your RRSP.
Home Buyers’ Plan (HBP)
The Home Buyers’ Plan enables you to withdraw up to $35,000 tax-free to put towards your first home purchase as long as you meet the Canada Revenue Agency’s (CRA) eligibility criteria and conditions. Repayment of the funds starts two years after withdrawal and must be paid back within fifteen years.
Withdrawing from an RRSP at maturity
At maturity of your RRSP, you can access your assets through following three options:
Lump-sum withdrawal: You can withdraw all of your funds within the RRSP. This withdrawal would be subject to withholding tax as the RRSP withdrawal amount must be included as income when you file your taxes.
Convert to an RRIF: You can choose to convert your RRSP to a Registered Retirement Income Fund (RRIF), which gives you a steady flow of retirement income with a minimum amount that must be withdrawn each year. You can start a RRIF at age 55, but you may risk running out of money.
Purchase an annuity: You can purchase an annuity that will offer you a guaranteed income for life or for a specific period of time. An annuity purchase is not subject to withholding tax, but you may have to pay tax on the income when you start receiving payments.
Withdrawing from an RRSP before maturity
Any funds withdrawn from your RRSP before you turn 71 are subject to withholding tax depending on the province you reside in. In addition, your withdrawals must be reported on your tax return as income and taxed at your marginal tax rate. When you withdraw funds from an RRSP, you permanently lose the contribution room you initially used to make your contribution.