16

Tax Deferred Investing – RRSPs 101

An RRSP is a Registered Retirement Savings Plan that you establish, the Canada Revenue Agency registers, and to which you or your spouse or common-law partner can contribute to.

RRSP facts

  • An RRSP is an account, not a mutual fund or an investment itself.
  • Contributions to an RRSP are tax deductible, so you can use these tax deductions to reduce your taxable income.
  • Some Canadians shouldn’t use an RRSP (their income may not be high enough (yet) to reap the key benefits of this account).
  • RRSPs are highly effective for Canadians who will be in a lower tax bracket in retirement versus their contribution years.
  • Contributions to an RRSP for the current tax year do not always have to be made in February.
  • There are contribution limits for an RRSP, but most Canadians will have a difficult time reaching their contribution limit year after year after year.
  • Contribution limits are based on the contributor’s “earned income” and can be found on his/her tax notice of assessment.
  • There are penalties if you over-contribute to your RRSP although a small exemption exists.
  • Unused RRSP contribution room can be carried forward, for future tax deductions in future tax years.
  • After you select investments for the account, the income you earn on those investments inside the RRSP are tax exempt, as long as money stays in the account.
  • A common type of RRSP is an individual RRSP, registered in the name of the person contributing to it.  There are also spousal RRSPs and group RRSPs.
  • RRSPs can be managed by a professional money manager but you can do-it-yourself (self-directed).
  • If one spouse is in a different tax bracket than his/her partner, RRSP contributions can be used to lower the total amount of income taxes a couple must pay (income splitting).
  • You’re not as rich as you think:  when you take money out of the account, you have to pay tax.  Some exceptions apply:  RRSPs can be used for home purchases and education and there are programs associated with the RRSP for this.
  • There are rules and age restrictions when you must collapse the account.
  • Withholding taxes apply if you make an “early” withdrawal from the RRSP.

These are just some of the RRSP facts.

Why RRSPs should matter to you

As referenced above, there are two great tax benefits that RRSPs provide Canadian investors:

  1. a tax deduction from your contribution, and
  2. tax-deferred growth.

With your tax deduction, you can reduce the taxes you pay today.  With tax-deferred growth, investments in your RRSP can compound over time without being taxed as long as money made stays in the account.

For most Canadians, to reap the benefits of this tax-deferred account they should maximize their contributions where it makes sense (based on their earned income), keep the fees associated with their investments inside the account low and avoid making withdrawals for as long as possible.  For further reading, check out the Canada Revenue Agency site here.

What’s your take on RRSPs?   Use them?  Maximize them?  

 

Filed in: Financial Terms 101, RRSP

16 Responses to "Tax Deferred Investing – RRSPs 101"

  1. Mark, in reference to your point on withholding taxes for early withdrawals, one thing people have to be aware of when they withdraw from their RRSP is that there are statutory rates applied; often the statutory rates are lower than your actual marginal rate, causing substantial income tax to be owed at tax time. ie: you withdraw $50k and the tax withheld is only $15k, if you are in the high rate of tax (partially caused by the $50k being added to your income), you could still owe $8k.

    • BetCrooks says:

      Good point, Mark! And it get’s even worse when people think they are beating the tax system by making several small withdrawals from their RRSP so that the withholding tax is very low. They really get hit when they calculate their taxes in April and realize they owe not just the withholding taxes they evaded before, but even more on top of that.

      • Exactly Mark’s (Blunt Bean Counter’s) point as well. I think folks that don’t understand the tax implications of an RRSP, are in for a big shock, especially seniors thinking they will get to “keep it all”. This is why I prefer to call this a tax deferred account, you are only putting off the inevitable… :)

    • Excellent point and thanks for that addition. With those rules and taxes applied, it is a punitive account to make early withdrawals from; purposely, and folks should be mindful of this.

  2. Barbara says:

    I am making withdrawals from my self directed RRSP now. I find the mandatory tax withholding rates high. I’ve been a stay at home mom without income for a number of years, so it is funny to have income tax taken off at source.

    Yes, I will get that extra tax refunded, but with the long wait. Then it will be re-invested. You think you have a lot of money saved in your RRSP, but then you realize you don’t really have all that money, you only have the after-tax portion.

    Tax rates in Canada now are very low compared to 25 years ago, so now is a pretty good time to make withdrawals if you are wanting to run down your RRSP.

    • Thanks for the comment Barbara. I too, find the withholding tax high, not sure that will change? Never say never I guess.

      For a rough estimate, I always “chop” my RRSP savings in half, that’s pretty much what I’ve saved. That’s doesn’t amount to very much, less than 6-figures unfortunately but I’m working on that.

      I suspect if I want to retire early, I’ll need to withdraw from my RRSP as well.

      What are you doing with the money you withdraw? Spending? Putting into non-registered investments? Putting into TFSA? Do tell if you can.

      Cheers,
      Mark

  3. Barbara says:

    I will put the money I withdraw into non-registered investments. In the last couple of years I have bought TD e-series index funds, the US fund has done great.

    I haven’t had a good return on my RRSP portfolio over the past decade; too much loss due to fees etc. I suppose. I am hoping for a better return over the next while….but who knows. I don’t have a pension from my working days, only the RRSP, and the CPP that I will get is low, due to limited years in the workforce.

    I am also considering buying a one bedroom apartment for rental. Unlike the rest of the country, prices where I live went down years back and have never recovered. I’d do this to rent it to one of my kids, instead of them paying a high rent to someone else. I have another rental property that yields a fairly decent rate of return on my investment, (my contribution was less than $50,000, the rest is financed) but rentals can be a hassle. The low mortgage rates definitely help make it profitable.

    Of course as soon as January comes I will be making the TFSA contributions for the year. I also have this as a TD Waterhouse account, e-series funds.

    I enjoy your blog!

    • BetCrooks says:

      @Barbara
      I hope you already know that when you do apply for CPP you will need to call them and ask to have the years you were at home with a child under 6 “dropped out.” They don’t automatically give you this improved calculation, but you are entitled to it if you ask. (Assuming you had no income for one or more years while you had a child at home who was under 6.)

  4. I’m 25, and have had an RRSP since I was 22. I also have a pension from work. I contribute monthly to my RRSP but recently have decided to increase my contributions as I have been working a lot of jobs from home, increasing my income, and I don’t want to be caught having to pay an insane amount of taxes at the end of the year. Plus – I want to retire eventually! My RRSPs are in mutual funds (balanced growth) and have been doing really well.

  1. […] About 1/3 of your RRSP is actually a government loan, only some RRSP money is yours to keep. […]

  2. […] contributions, it would seem to make sense to keep money in this account for as long as possible.  The rules of the RRSP are constructed to encourage investors to keep investments (e.g. individual stocks, Exchange Traded Funds (ETFs), […]

  3. […] account or better still a Tax Free Savings Account (TFSA) before you’re forced to.  As part of the RRSP primer I wrote here, you already know that if you have one or more RRSPs you’ll be required to shut those accounts […]

  4. […] During the past “RRSP Season” I received a few emails from readers asking about Exchange Traded Funds (ETFs).   This particular question caught my attention: […]

Leave a Reply

Submit Comment
*

Top of Page

Copyright © 2009 to 2915 by My Own Advisor. All Rights Reserved. Admin
Powered by Theme Junkie  •  Designed by Dividend Ninja