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 to RRSP withdrawals.

If you’re taking money out of your RRSP before you retire, you’re immediately going to pay a withholding tax.

  1. If you take up to $5,000, you’re going to pay 10%.
  2. If withdrawals are between $5,000 and $15,000, the financial institution will hold back 20%.
  3. If you withdraw more than $15,000, 30% is held back.
  • You have to report the amount you take out on your tax return as income. At that time, you may have to pay more tax on the money — on top of the withholding tax. It depends on your total income and tax situation.

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.

Based on my personal investment plan, I invest using an RRSP.  Be careful though – the RRSP-generated tax refund is great but it’s actually temporary; you need to give it back at some point.  This makes reinvesting the RRSP refund year after year absolutely critical in my opinion to optimize wealth building – to take major advantage of an essentially a long-term but not permanent government loan.

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.

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

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17 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.

    1. 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.

      1. 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… 🙂

  2. 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.

    1. 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.


  3. 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!

    1. @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.)

      1. Thanks. I do know about that, but it is important to always get that word out. I had 11 years of kids under 6 and last child had/has disabilities so I couldn’t return to paid work even if I had wanted to.

  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.

  5. I will make approximately 100k this year, next year I am taking a year off to be with my kids. I will have no income. Can I puchase 10k RRSP this year dec 2014, then in jan 2015 withdraw the same amount 10k. I would be paying half the tax on the 10k , yes?

    1. Thanks for your question Ted. Dec. 2014 and Jan. 2015 technically fall within the same RRSP contribution year although you don’t have to count it as such. RRSP contributions do not have to be deducted in the year they are made, they can count in any future year.

      You probably know you can withdraw from your RRSP whenever you want but you will have withholding taxes charged on money withdrawn if not converted to a RRIF beforehand. I recall I put that in the article.

      If you can afford to make a RRSP contribution this year, but you’re going to take it out in less than a month, why not just keep the money in cash? Just a question, not advice, since I typically use my RRSP for long-term savings.

  6. Just found this post while scanning through something else.

    On your last point Mark I think it’s safe to say withdrawal taxes apply on all RRSP withdrawals for income.

    On the tax deferral idea of an RRSP I agree it could be considered as a government loan and not tax free. However the 1/3 number is likely much too high a tax rate for most people. To pay that kind of tax you would need to withdraw $100K range RRSP with no other income or 75+K RRSP with 14K of CPP/OAS. Those are obviously large amounts of withdrawal and income to create 1/3 taxes, and also create OAS clawback. More realistic is probably a tax rate closer to half that although your withdrawal amount, provincial residence and other income etc of course will impact all of this.

    1. You’re probably right Deane and like usual, I am being overly conservative. That 1/3 number is what we are using for our tax rate. We won’t have enough funds to make that kind of RRSP withdrawal. I do anticipate we will draw down the RRSP by at least $10,000 per year ($5k each) in our 50s. We hope to deplete most of our RRSP or move RRSP withdrawals to TFSA in our 50s and 60s before both CPP and OAS payments kick in.


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