With the variety of savings account options available to Canadians today, trying to decide where to save your money can be tricky, but if you’re saving for retirement, a Registered Retirement Savings Plan (RRSP) is a popular option.
Here are the RRSP basics, including how much you can contribute to an RRSP, when to make withdrawals, whether a spousal RRSP is for you, and how to convert your RRSP to a RRIF. We’ll also uncover more tax-efficient ways to use your RRSP; such as buying a home using the Home Buyers' Plan and paying for your education with the Lifelong Learning Plan.
How an RRSP helps you save for retirement
An RRSP (Registered Retirement Savings Plan) is an investment account that helps you prepare for retirement by growing your money and sheltering it from taxes. For every dollar you place into an RRSP, you can take a deduction against that year’s income. This means you could get a higher tax refund. Also, you don’t pay tax on the interest, dividends, or capital gains your investments earn. Taxes are deferred until you withdraw funds (with a couple exceptions - like the Homebuyers' Plan and Lifelong Learning Plan). The idea is that if you wait until retirement to withdraw the funds you’ll be in a lower tax bracket than you were when you made the contribution.
Think of an RRSP as an investment basket in which you can hold different types of investments; GICs, stocks, mutual funds, exchange-traded funds, and even cash may all be held in your RRSP.
How much you can contribute to an RRSP
Your RRSP contributions are capped at 18% of your previous year’s annual income, to a maximum of $29,210 for 2022. In 2023 the limit increased to $30,780 for the 2022 taxation year. You may make additional contributions if you haven’t used up all of your previous years’ unused contribution room (going back to 1991).
The best way to contribute to an RRSP is by making regular, automated contributions using a pre-authorized contribution plan.
When to withdraw from an RRSP
If your RRSP funds are not “locked in” you can make withdrawals anytime, but you will have to pay withholding tax. The amount you withdraw will also be added to your income for that year. The amount of withholding tax you’ll pay depends on how much you withdraw. For any amount withdrawn up to $5,000 you’ll pay 10%, 20% for withdrawals between $5,000 and $15,000, and 30% for withdrawals over $15,000.
While emergencies can happen, ideally, you won’t need to make withdrawals from your RRSP until you’re retired and in a lower income tax bracket.
Is a spousal RRSP for you?
For families with spouses in different tax brackets, having the higher-earning spouse contributing to a spousal RRSP for the lower-earning spouse makes good financial sense. This results in a higher tax refund today and a lower tax rate at withdrawal, assuming today’s lower-taxed spouse is tomorrow’s lower-taxed retired spouse.
Converting RRSPs to RRIFs for retirement income
December 31 of the year you turn 71 is the last day you can contribute to your RRSP. After that, you have to withdraw the funds from your RRSP. You do this by converting your RRSP to a Registered Retirement Income Fund (RRIF), purchasing an annuity, or both. Remember, while the amount you’re required to take as RRIF or annuity payments depends on your age, your withdrawals will be taxable.
Using your RRSP to buy a home
First time home buyers struggling to come up with a down payment can make a tax-free RRSP withdrawal of up to $35,000 to purchase a home through the Home Buyers’ Plan (HBP). You will then have 15 years to make equal installment contributions back to your RRSP to replace the funds you withdrew under the program. If you miss a contribution, that year’s amount will be added to your taxable income for the year.
Using your RRSP to pay for your education
Thinking about going back to school full-time to pursue a post-secondary degree or diploma? If so, you could withdraw up to $10,000 from your RRSP under the Lifelong Learning Plan (LLP). Your spouse or common-law partner can also withdraw up to $10,000 from their RRSP for the LLP the same year you do. You can use these funds to help cover education costs while attending an eligible university or college. You will then have 10 years to make equal annual installment contributions to your RRSP to replace the funds withdrawn under the LLP. If you miss a payment, the amount will be added to that year’s taxable income.
Learn more about RRSP options from Meridian
A version of this article was originally published on December 27, 2018