Education - Registered Retirement Savings

WHAT IS AN RRSP?

A Retirement Savings Plan (RSP) is an investment account designed primarily for saving towards your retirement years. As a Canadian government regulated program, RRSPs have special tax benefits. Your annual RRSP contribution can greatly reduce the amount of income tax you pay in that year and the money you put away can have years of tax-deferred growth potential. You only pay tax on the amounts you withdraw. RRSPs are available through credit unions, chartered banks, trust companies and other selected financial institutions.

What makes an RRSP special is that your contributions to it are tax deductible and your portfolio grows tax sheltered. Individuals with RRSP contribution room in Canada may contribute to an RRSP up to the end of the year in which the plan holder reaches age 71.

Who Should Have An RRSP?

Every individual who works, files a Canadian income tax return, and looks forward to a secure retirement should consider having an RRSP.

Here's why:

  • People, who earn income through their employment or self-employment, can reduce their annual tax bill while saving for their future through an RRSP.
  • For people who have a company pension plan, RRSPs add extra comfort that their retirement needs are met; for those that don't have company pension plans, RRSPs may be the foundation for funding their retirement.
  • Married couples where one spouse earns more income than the other can reduce their combined tax burden through a spousal RRSP. At retirement, an income-splitting strategy can be applied to reduce overall tax when the funds are withdrawn.
  • If you are planning on purchasing your first home or are interested in continuing your education, you can contribute to your RRSP, and then use these funds as a source of financing.
  • If you anticipate fluctuations in your income because of maternity leave, career change or employment interruptions, the funds in an RRSP are always available to you.

What Are The Benefits of RRSPs?

While designed specifically as a retirement vehicle, an RRSP has benefits throughout your lifetime;

  • By contributing to an RRSP throughout your working career, you'll realize immediate tax benefits at a time when your income is generally highest. The total amount of your annual contribution can be deducted from your gross income at tax time, reducing the amount you pay in income tax that year.
  • The income earned in your RRSP is not taxed until it is withdrawn. While your investments sit in your RRSP, their growth is tax sheltered and so the total value may grow more quickly.
  • By the time you begin to withdraw the funds at retirement, you will probably be in a lower tax bracket than during your earning years. Funds withdrawn at that time will benefit from this lower tax rate.
  • Special features of RRSPs allow you to do further tax planning or use your RRSP to fund specific life events.

It's important to understand the details regarding RRSPs. The rules governing all RRSPs are set out in the Federal Income Tax Act and are administered by the Canada Revenue Agency. Below we have summarized the key aspects you should know.

Annual Contributions

You may contribute to your RRSP until December 31 of the year in which you reach age 71. 

Your allowable RRSP contribution for the current year is the lower of;

  • 18% of your earned income from the previous year, or
  • The maximum annual contribution limit for the taxation year, or
  • The remaining limit after any company sponsored pension plan contributions.

Earned income includes salary or wages, alimony received, and rental income, among other income sources, but does not include items such as investment income. You’ll find the exact amount you can contribute to your RRSP for the current year on the Notice of Assessment you receive from Canada Revenue Agency after they process your previous year's tax return.

Company Pension Plan or Deferred Profit Sharing Plan
As a member of a company-sponsored registered pension plan or deferred profit sharing plan, the amount that you can contribute to your RRSP must be reduced by the total value of the pension credits you earned for the year.

This amount is referred to as a pension adjustment (PA) and it is reported on the T4 slip (Statement of Remuneration Paid) that you receive from your employer.

Annual Contribution Deadline
To be eligible for an RRSP deduction in a specific taxation year, you can make contributions anytime during the year, or up to 60 days into the following year.

Carry-forwards
If you can't make your maximum contribution one year, you can make up that portion of the contribution in later years by carrying it forward. The amount of your unused contribution limit is shown on your federal Notice of Assessment. You may also choose to delay claiming your current year's RRSP tax deduction. To take the deduction in a later year, you must make sure that your allowable deduction limit has not been reached.

Over-Contributing to your Plan
If you make an RRSP contribution beyond your maximum allowable amount for a year it is considered an over-contribution. There is a lifetime allowance of $2,000 for over-contributions. These contributions must be used before any new contributions are applied.

Transfers between RRSPs
You may open as many RRSPs as you wish. You are free to transfer your RRSPs between financial institutions at any time without being subject to tax. You can also move some or all of your money between eligible investments within your RRSP.

Withholding Taxes
Funds withdrawn from an RRSP will be charged withholding taxes. This amount must be held back by the plan administrator and remitted to the government on your behalf.

Effective January 1, 2005, the following withholding tax rates apply

Amount of RRSP
Withdrawal

All Provinces
Except Quebec

Quebec

Up to and including $5,000

10%

21%

$5,001 to $15,000

20%

26%

More than $15,000

30%

31%

You will receive a T4 RRSP receipt for any funds withdrawn during the year showing the amount to be included in your taxable income and the credit for the withholding tax.

Separation or Divorce
During separation or divorce, either you or your spouse can transfer existing RRSPs to the other, without being subject to tax, provided that;

  • You are living apart when property and assets are settled, and
  • You have a written separation agreement or a court order.

Death of a Plan Holder
In the event of death, the proceeds of your RRSP are distributed to the person/s named as your beneficiary or to your estate, if no beneficiary has been designated. This designation can be specified in either your RRSP or in your will. Quebec residents must make the designation by will or marriage contract for most plans. There are rules that govern when tax is payable and when it is deferred upon the death of an RRSP annuitant. When designating a beneficiary on your RRSP, it is important to understand what the implications are and remember that the tax will eventually be paid.

The proceeds of the RRSP will remain tax-sheltered if one of these situations applies;

  • Your surviving spouse is the beneficiary, and the proceeds are transferred into an RRSP or a Registered Retirement Income Fund (RRIF) in his/her name; or
  • You have no surviving spouse, but you have children or grandchildren who are minors named as your beneficiaries. They are dependent on your estate for financial support and will have the proceeds transferred to a term annuity registered in their names; or
  • Children or grandchildren, regardless of age, who are financially dependent because of physical or mental infirmity. The RRSP proceeds will be transferred to an RRSP or RRIF registered in their names, or used to purchase an annuity.

When someone other than the spouse or financially dependent child/grandchild is designated as the beneficiary of the RRSP (such as the adult child/children) the RRSP will be paid to that individual with no tax withheld. However, the estate will be responsible for the entire tax payable.

This can result in inequitable distribution. For example, Mom’s intension is that her 3 children each receive an equal 1/3 share of her estate. Child “A” is the designated beneficiary of Mom’s RRSP. Child “A” will receive the RRSP proceeds with no tax withheld; the estate will pay the full tax payable, thus reducing the residue of the estate and creating an unfair distribution to children “B” and “C”.

You should consider an RSP if;

  • You want to supplement your retirement income so that you can maintain your lifestyle after you retire.
  • You want to reduce your income tax this year.
  • You want to earn tax-deferred investment income on your savings.
  • You anticipate fluctuations in your income because of maternity leave, a return to school or a career change.

Making withdrawals from an RSP in years when you have little or no earned income can help equalize your income and you could pay less income tax overall.

Emergencies
Your RRSP holdings can be used to cover an emergency situation. However, there is a tax consequence to doing so and an impact on your retirement plan. Any withdrawal is considered taxable income for the year and a withholding tax will be charged upfront when you withdraw the funds.