Understanding RRSPs

Understanding Registered Retirement Savings Plans (RRSPs)

When it comes to planning for retirement, the process can be confusing. An important factor in any successful retirement plan is to make sure you enough savings set aside. One great way to create a nest egg for the future is by taking advantage of Canada’s official Registered Retirement Savings Plan (RRSP).

What is a Registered Retirement Savings Plan?

A Registered Retirement Savings Plan, or RRSP, is a personal tax-sheltered savings plan registered with the Canadian federal government and meant for retirement.

You make tax-deductible contributions to a portfolio of investments that grow on a tax-sheltered basis. These investments can include RRSP savings deposits, treasury bills, guaranteed investment certificates (GICs), mutual funds, bonds, and even equities. The income earned in the RRSP is not taxed until you withdraw it.

How RRSPs work

You set up an RRSP through a financial institution, such as a bank, credit union or caisse populaire, insurance company, or online brokerage, and make contributions to it through that same institution. You can choose a plan with the kind of investments you’re comfortable with, or, if you want to control your assets and make your own investment choices, you can set up a self-directed RRSP. You can make contributions for a given year from March 1 of that year until 60 days into the following year.

The amount you can contribute to an RRSP in a given year is a percentage of your earned income from the previous year, up to a fixed dollar amount. In 2017, you can contribute up to 18% of your 2016 earned income, but no more than $26,010. The limit is reduced if you have a company pension plan or deferred profit-sharing plan.

You can contribute to an RRSP until the end of the calendar year in which you turn 71. After that, you can still contribute an amount up to your own deduction limit to a spousal or common-law partner RRSP if the partner is 71 or younger at the end of the year in which you’re contributing. Spousal or common-law partner RRSPs are plans registered to and controlled by the partner who earns less.

If you don’t contribute the maximum allowable amount in a given year, you can carry forward the shortfall and make up the difference in a later year. You can also consider an RRSP loan, where you borrow money to maximize your RRSP investment. Make sure the interest you’ll pay will be less than the expected tax savings.

In addition to tax-deferred contributions, you can transfer certain funds, such as registered pension plan (RPP) lump-sum payments, to an RRSP. These don’t count toward your contribution limit.

You can also contribute non-cash “in-kind” assets (stocks or securities) to an RRSP. These will be valued at the security’s fair market value at the time of the contribution.

The fees you’ll pay to manage your RRSP vary depending on the plan. Make sure to find out about all fees, transaction costs and other expenses when you research plans.

Benefits of RRSPs

People in many circumstances can benefit. An RRSP is recommended for anyone who doesn’t have a company pension plan, or has such a plan and wants to supplement it. For couples with unequal incomes, contributing to a spousal or common-law partner RRSP can reduce taxes upon retirement. You can contribute all or part of your allowable contribution to a spousal or common-law partner RRSP instead of your own.

You’ll likely pay a lower tax rate when you withdraw than when you contribute. For most people, the tax benefits of contributing to an RRSP occur during your higher-income (working) years. So when you withdraw the funds after you retire, you will benefit from a lower tax rate.

The growth of the investments in your RRSP are tax sheltered. Thus, the total value of your plan may grow faster. The income isn’t taxed until it’s withdrawn.

With a self-directed RRSP, you can invest in a greater variety of investments in the same account. While some managed RRSPs are restricted to certain types of investments (mutual funds or GICs, for example), a self-directed RRSP gives you more freedom, control, and the advantage of being able to place your trades and review your portfolio online. However, in spite of the name, it does not have to be self-managed—a financial adviser can help you. Typically, self-directed RRSPs have annual trustee fees, but overall administration fees tend to be lower than for a managed RRSP.

Funds can be used pre-retirement for a first home or an education.

Through the Home Buyer’s Plan and Lifelong Learning Plan, you can draw up to $25,000 in RRSP funds before retirement for purchasing a first home or continuing your education.

There is no penalty on this type of loan. Repayment of these funds to the RRSP is required but can be made over a period of up to 15 years. Repayments do not count as contributions to the plan.

When an RRSP might not be the best choice

Fees can be high. You may be charged administration fees of one, two, or more percentage points of your fund’s value. Shop around and compare costs before choosing a plan.

RRSPs aren’t all-purpose savings vehicles. For saving for purposes other than retirement, like travel, trading up to a bigger home, paying for your children’s college education, or creating an emergency fund, an RRSP is probably not the right choice. Withdrawing funds from an RRSP before retirement will cost you a very large tax penalty, except under the Home Buyer’s and Lifelong Learning Plans.

RRSPs have few benefits for low earners. If you are in a low tax bracket, an RRSP’s tax advantages and other benefits may not apply, as the tax deduction will have little or no value, and your taxable income may not be lower when you retire.

The foregoing content is provided as general financial information. It is not intended to be financial advice and cannot replace a consultation with a financial advisor in your province.

Looking for more information? Life Works can help.

For confidential advice and support, contact us at (Canada, English): 1-877-207-8833 or visit LifeWorks.com.

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