Your guide to understanding an RRSP brought to you by the Modern Money research team.
What is an RRSP?
An RRSP, short for “Registered Retirement Savings Plan,” is designed to help individuals save for retirement. In a world where pensions are less common, many Canadians take charge of their retirement by utilizing an RRSP.
This tax-advantaged account deducts contributions from your taxable income for the year, offering an attractive feature. The tax on these contributions is deferred until you decide to withdraw the funds. The key advantage is reducing taxable income, leading to substantial savings, especially considering your tax bracket.
How Does this Work?
An RRSP is effortless to open, and numerous financial institutions offer a wide array of options. Search for an institution with low fees, direct-deposit capabilities, and no minimum contributions, giving you the freedom to contribute when ready and on your own terms.
To determine your RRSP contribution for any given year, calculate either 18% of your previous year’s income or the maximum amount, whichever is lower. For 2023, the deduction limit is $30,780. Your RRSP contribution limit is unique to you, allowing for potential rollovers from unused contribution room in previous years.
Calculate RRSP contribution room by tracking previous contributions and their respective yearly limits. This sounds difficult, doesn’t it? We agree. Well, thankfully there is an easier solution. The CRA keeps track of your contribution limit for you and they report it on your Notice of Assessment each year. You can also log in to your CRA My Account and see your RRSP contribution limit there (further information on the benefits of setting up online access with the CRA here).
Benefits of an RRSP
As mentioned earlier, contributing to an RRSP can significantly reduce your current-year tax bill. For instance, suppose you earned $80,000 this year and contributed $10,000 to your RRSP. When it’s tax time, the CRA will consider your income as $70,000, providing valuable tax savings. However, keep in mind that this strategy defers taxes to retirement when you withdraw the funds.
There is also a recent program introduced by the Canadian government named the “Home Buyers Plan” (HBP). Briefly, the HBP allows eligible first-time home buyer’s to withdraw up to $35,000 tax-free from their RRSP to use towards a down-payment for the purchase of a home. For more info on the HBP, check out our recent article by Winnipeg Real Estate Agent, David Stasica: Understanding the Home Buyers’ Plan.
In addition to the HBP, another exciting program that just came out is the First Home Savings Account. The FHSA operates with the benefits of a TFSA (tax-free growth) and still allows you to reduce your taxable income similar to an RRSP. To learn more about the FHSA, click here.
For more articles on personal finance and investing fundamentals by the Modern Money research team, click here.