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What is a Registered Retirement Savings Plan? How does a Registered Retirement Savings Plan work?

Updated: Jan 10


RRSP's are a good addition to your retirement plan
RRSP's grow tax free over your life time

A Registered Retirement Savings Plan (RRSP) is a tax-advantaged savings account available to Canadian residents to help you save for retirement. It's designed to encourage you to save by offering tax benefits.


How a Registered Retirement Savings Plan works:


  1. Contributions: You (the account holder) can contribute a portion of your earned income to the RRSP each year, up to your contribution limit, which is a percentage of your previous year's income. Contributions are tax-deductible, meaning they reduce your taxable income for that year. The unused contribution room can be carried forward to future years.

  2. Investment Growth: Once the money is in the RRSP, it can be invested in a variety of financial instruments such as stocks, bonds, mutual funds, GICs (Guaranteed Investment Certificates), etc. The income earned from these investments—interest, dividends, and capital gains—is sheltered from immediate taxation.

  3. Tax Deferral: Taxes on RRSP contributions and investment growth are deferred until you withdraw money from the plan. The idea is that when you retire, your income might be lower, so you'll potentially be in a lower tax bracket and pay less tax on the withdrawn amount.

  4. Withdrawals: When you withdraw money from your RRSP, it's treated as regular taxable income at the current tax band rates in the year you take it out. Your withdrawals will push you into a much higher tax band. There are, however, programs like the Home Buyers' Plan and the Lifelong Learning Plan that allow tax-deferred withdrawals for specific purposes (such as buying a first home or funding education).

  5. Conversion: At a certain age (usually by the end of the year you turn 71), you're required to convert your RRSP into a Registered Retirement Income Fund (RRIF) or purchase an annuity, which provides you with regular retirement income. Withdrawals from RRIFs are subject to minimum annual withdrawal amounts and are taxable at your full marginal tax rate

  6. It's important to note that RRSPs have contribution limits, and exceeding these limits may result in penalties.


While RRSPs offer tax advantages, they might not be the best option for everyone, as individual financial situations vary. Consulting a financial advisor or tax professional can help you understand if an RRSP is suitable for your retirement savings strategy.


Detailed Description of RRSP inner workings

  1. An RRSP is a registered retirement savings plan that allows you to make tax deductible contributions up to age 71.

  2. RRSP’S provide tax sheltered income, growth, and capital gains

  3. RRSPs attracts the highest marginal tax rates when you retire, start withdrawing for an income, or die without a spouse or partner to roll your plan into theirs

  4. The year you turn 71 you must convert your RRSP - RSP to a RRIF-RIF Registered Retirement Income Fund) then withdraw the mandatory minimum of 5.28%  (This increase to 20% by age 90).  Or you are taxed by CRA even if you don’t take this money out of your RIF.  Withdrawals from your RIF are taxed at your highest marginal income tax rate

  5. Depending on your circumstances marginal tax rates as high as 50% may be applied by Canada Revenue Agency (CRA) when you die!

  6. RRSP's are not for everyone, and for lower income earners (below $45,000 YR) may not be appropriate in light of the TFSA contribution room now available.  RRSP's may be appropriate for you depending on your needs, resources and stage of life

  7. In light of the recent changes in the taxation of small businesses its better to take a salary to reduce corporate tax and increase your RSP contribution room and CPP contributions

  8. For younger folks just starting out its best to maximize your TFSA savings and investments. Wait until your earnings move into a higher tax bracket to start an RRSP so your tax savings are much higher. Use your tax refund to add to your TFSA investments each year. 

  9. For older or retired folks with high 6 figure or 7 figure RRSP accounts get ready for a big tax problem. If you want to pass your RRSP savings to your children you should consider buying a life insurance policy to cover your future tax liability.

  10. When you die with no spouse to pass your RRSP/RIF to your estate must include the full amount in your terminal (final) personal tax return as income. If there are amounts over $220,000 your final tax return shifts into the 53% tax band. Any accounts that are now single owned (not jointly owned) with balances over $50,000 are now required to go through probate

 

Group RRSP contributions are made pretax by your employer so you won’t get a tax refund. And is viewed by CRA as a taxable benefit. That will be offset by your RRSP contribution room. The next tax year this contribution is subtracted from your contribution room through a PA Pension Adjustment $ amount.

 

Personal RRSP contributions are made with after tax dollars so you will get a tax refund as long as you have sufficient contribution room



RRSP Strategies to Minimize Tax

  1. If you earn below $45,000 taxable income an RRSP is not a great long-term strategy as it generates a refund of 22% of less. 

  2. If you're a first-time home buyer max out RRSP contributions to save your $35,000 for your HBP withdrawal. 

  3. If you earn higher taxable income of $130,000 an RRSP might just be a great idea as each dollar contributed generates a refund of up 47 percent

  4. Withdraw (deregister) your money from your RSP in low tax years or low-income years before retirement

  5. Deploy an RRSP meltdown strategy of using leveraged investment loan interest to offset taxable income triggered by an early RSP withdrawal

  6. Use the RRSP meltdown strategy to convert your RSP to a Non-Registered Investment Account if you have significant fixed pension income

  7. Hold US stocks in your RRSP to avoid the 15% with holding tax

  8. Save and invest your tax refund in your TFSA

  9. Save and invest you tax refund in your RSP

  10. Convert RRSP to RIF early then delay taking CPP to generate a return of 7% per month or 8.4% for each year you delay applying. Provides 42% higher CPP payments by age 70

  11. Early RIF withdrawals can potentially reduce OAS claw backs later on

  12. If a couple each has an RRSP, they could RIF one early then income split

  13. Max out RRSP contributions, just pay the tax when you retire, but take out permanent life insurance to pay your future tax bill 

  14. Borrow to make an RRSP contribution if you're in the highest tax bracket

  15. Make your contributions at the beginning of the year to give your money longer to grow

  16. If your marginal tax rate is lower in retirement that it was when you were working then these RRSP tax strategies are working


The following Investments can be held in an RRSP, RRIF, RIF:

 

RRSP investments can include the following: Cash, GICs, Savings Bonds, Treasury Bills, government bonds, corporate bonds and strip bonds, gold and silver bars certificates, RRSP eligible Mutual Funds, Segregated Funds, Guaranteed Minimum Withdrawal Benefit, ETFs, Canadian and foreign stocks, some derivatives and options, Canadian mortgages, Mortgage-backed securities, and Real Estate Investment Trusts. Best investments are those that generate 8% to 12% annual returns.

 

Some personal finance industry bloggers and investment companies have biases and conflicts of interest that are not properly disclosed to the prospective investor. Agile Financial Services believes that all biases and potential conflicts of interest should be properly disclosed in writing before any investment decisions are made


Which is Better an RRSP or TFSA? 

Many internet personal finance writers claim that RRSP contributions are made in after tax dollars. In fact, most personal RRSP contributions are made after your income tax was deducted. Your refund tax rates are usually in the range of 22% to 47% per dollar. 

Contributions to both RRSP's and TFSA`s are made with after tax dollars. Except for employer Group RSP contributions which are made pretax and not classed as a taxable benefit as long as you have adequate contribution room. Both RRSP`s and TFSA`s provide tax sheltered income, growth and capital gains

 

  1. Capital gains and losses are not tax deductible in either RRSP`s or TFSA`s

  2. Account fees are not tax deductible in either RRSP`s or TFSA`S

  3. Interest on borrowing to invest in either RRSP`s or TFSA is not tax deductible

  4. RRSPs are for retirement income. TFSAs are to save and invest for any financial goal but work best for long term investments and retirement income planning

  5. Personal RRSP contributions are tax deductible on your annual tax returns. TFSA contributions are not tax deductible

  6. RRSP withdrawals are taxed at your highest marginal tax rate. TFSA withdrawals generate no income tax and are TAX FREE

  7.  After you turn 71 you can’t make contributions to your RRSP; you must convert it to a RRIF.  There are no age limits with a TFSA

  8. You need earned income to deduct an RRSP contribution.  You need after tax dollars to contribute to your TFSA

  9. When you're retired withdrawals from your TFSA don’t reduce government benefits. RRIF withdrawals usually reduce government benefits



RRSP withdrawals attract withholding tax of up to 30%

Taking money out of your RRSP account prior to retirement requires you to report it on your income tax when you file. The financial institution that administers your RRSP also withholds a certain percentage of the money you withdraw, depending on the amount. The CRA RRSP withholding tax works as follows:

 

RRSP Withdrawal Tax Rate

  • Withdrawals up to $5,000 — 10 percent tax is withheld

  • Withdrawals of $5001 to $15,000 — 20 percent tax is withheld

  • Withdrawals of $15,000 and up — 30 percent tax is withheld

If you make a pre-retirement RRSP withdrawal, you also may have to pay additional income tax at the end of the year. This depends on your tax bracket and if the withdrawal puts you into a higher tax bracket you may have to pay more income tax

 

Tips for getting more from RRSP`s

  • Employer group RRSP contributions are made in pre tax dollars

  • Personal RRSP contributions are made in after tax dollars

  • You can contribute to you RRSP any time as long as you have the contribution room and cash to do so.

  • You can make a contribution not deduct it then carry it forward to another tax year You don’t have to take the deduction in the year you made the contribution. You can defer taking the deduction to the following year if you know you’re going to be in a higher tax bracket the following year.

  • One of the many benefits is the option to carry forward your unused contribution room, and carry forward unused deductions to a higher tax year.  You can also defer contributions to a higher tax year.

  • When you don’t make use of your contributions you can still make a contribution to a spousal RRSP. However you can’t make contribution’s after you turn age 71

  • If you pass away before age 71 and your spouse survives you, is under age 71, you have unused contribution room and no deductions were made for prior contributions.

  • Your executor can make contributions and deduct them in the year of your death on your terminal tax return. The spousal contribution should be made in the year of your death or within the 60-day rule (the first 60 days of the next year anytime during Jan or Feb that following year.



Spousal/partner RRSP considerations

Always consider future tax liabilities when setting up your RRSP and TFSA, and your will.  When you pass away CRA considers there is a deemed disposition even if your investments were sold or not so they can they apply incomes taxes. Most assets can be passed tax free to your spouse or common law partner

 

RRSP’s, RRIFs have high tax liabilities because 100 % of their holdings are taxed when their owners pass away. When an RRSP annuitant dies (the owner), it’s often possible to roll over the RRSP to a qualified beneficiary on a tax-deferred basis. If the beneficiary is a spouse, common-law partner or a financially dependent child or grandchild with a mental or physical disability, the beneficiary can contribute the proceeds directly to their own plan, rolling over tax free to the beneficiary’s RRSP or RRIF (among other pension, annuity or RDSP options)


What Happens to my RRSP or RRIF when I die?

The total value of RRSP/RRIF investments or cash are taxable to the deceased tax return in the year of their death. Income or capital gains generated from the date of death to the date of you receive the proceeds are taxable when you get your loot. 

 

Your executor (or spouse) can rollover your RRSP/RRIF to your spouse’s RRSP, common law partner's or dependents RRSP or RRIF

 

When your spouse or common-law beneficiary (defined as a qualified beneficiary) includes your cash or investments from your RRSP or RRIF amount in their income tax return CRA classifies this as a “refund of premiums”. Your beneficiary defers (which effectively eliminates) the taxation on this amount by making a contribution to their RRSP or RRIF.

Transfer of assets in kind or in cash directly to the spouses RRSP of RRIF reported as income on their annual tax return then claims a tax deduction for the amount deposited in the RRSP or RRIF account.


Cash or investments are paid to the spouse then contributed to their RRSP or RRIF within 60 days after the end of the year that the spouse beneficiary received the RRSP proceeds


Converting RRSP`s to RRIFS (RIF`s)

Contributions can be made up to the end of the year you turn 71. At the end of the year, you reach age 71 you must convert your RRSP to a RRIF (REGISTERED RETIREMENT INCOME FUND). Your RRIF will pass to your spouse tax free when you pass away. When your spouse passes away the $ value of your RIF is added to your income that year then taxed at the appropriate marginal tax rate. RRSPs are a great self-directed saving for retirement vehicle. BUT you're kicking your income Tax Day of reckoning down the road. If you’re saving and investment activities are successful you or your spouse will pay significant income tax at some point.

 

Locked in RRSP’s OR LIRA’s Locked in Retirement Accounts

Is an RRSP with funds that have been transferred from a pension plan are locked in and withdrawals are restricted to hardship applications until retirement. Provincial legislation requires that these funds be locked-in. At the time of retirement, funds in a locked-in RRSP are converted to a life income fund. 



Spousal RRSP Advantages

If your spouse is not working or has a lower income than you consider contributing a spousal RRSP

A Spousal RRSP allows you to contribute to your Spouse’s RRSP? One spouse makes contributions to the other spouse’s RRSP. Be aware that when you do this your spouse now becomes the legal owner of the account and investments. And you no longer have a claim and this money. Spousal RRSPs are a great way to reduce income tax while you are working. Then redirect income to the lower income tax spouse during retirement

 

Your spouse has to wait for 3 years after your contribution to withdraw the same dollar amount that you contributed. Take the following example; If your spouse withdraws from their RRSP during 2016.  If you contributed to any spousal or common-law partners RRSP in 2014, 2015, or 2016 you probably have to report this as income all or part of these amounts your spouse withdrew

 

The spousal RRSP has five main benefits:

  1. Each spouse can have a retirement income that allows both to take advantage of the personal credit, the over age 65 credit, pension income splitting and pension tax credit when you turn age 65.

  2. Both spouses can split RRSP retirement income across 2 taxpayers instead of one

  3. Allows you to split incomes prior to age 65

  4. Both spouses can make withdrawals under the Home Buyers Plan and the Lifelong Learning Plan

  5. If you're over age 71 and have available contribution room you can make tax deductible contributions to your spouse’s Spousal RRSP, as long as your spouse is still under the age of 71


Annual RRSP Contribution Limits-Maximum Annual Contribution amounts from 2005 to 2024

You can contribute to the RRSP deduction limit of 18% of the previous years earned income, up to a maximum annual dollar limit. The current RRSP contribution limits are:

2005 RRSP Contribution Limit $16,500

2006 RRSP Contribution Limit $18,000

2007 RRSP Contribution Limit $19,000

2008 RRSP Contribution Limit $20,000

2009 RRSP Contribution Limit $21,000

2010 RRSP Contribution Limit $22,000

2011 RRSP Contribution Limit $22,450

2012 RRSP Contribution Limit $22,970

2013 RRSP Contribution Limit $23,820

2014 RRSP Contribution Limit $24,270

2015 RRSP Contribution Limit $24,930

2016 RRSP Contribution Limit $25,370

2017 RRSP Contribution Limit $26,010

2018 RRSP Contribution Limit $26,230

2019 RRSP Contribution Limit $26,500

2020 RRSP Contribution Limit $27,230

2021 RRSP Contribution Limit $27,830

2022 RRSP Contribution Limit $29,210

2023 RRSP Contribution Limit $30,780

2024 RRSP Contribution Limit $31,560

 

 

Borrowing to Contribute to a RRSP

 

Its not a good idea to borrow money to contribute to an RRSP unless:

  1. You’re in the tax bracket where you get a 35% to 45% tax refund

  2. You can afford to pay off the loan within 12 to 24 months

  3. You can afford to make an RRSP contribution from your annual cash flow.

Using the following example, we can understand if its worth it to borrow to make an RRSP contribution. Or is it worth it all to make an RRSP contribution

 

Taxable Income $ 75,000

Ontario tax $15,735

After Tax Income $59,265

Average Tax Rate 20.98%

Marginal Tax Rate 31.48%

Marginal Tax Rate on Capital Gains 15.74%

Marginal Tax Rate on Eligible Dividends 8.29%

RRSP Contribution $13500 Note RSP contributions are after tax income

Cost of Borrowing 4.75% for 12 months = $13,500 x 4.75% = $351 with monthly payments of $1,154.31

Tax Refund Ontario $4,037

If you apply your tax refund to pay off the RRSP loan then the loan only costed you $9,463

Interest on the RSP loan is not tax deductible


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