Your guide to understanding an RRSP brought to you by the Modern Money research team.
What is an RRSP?
RRSP is an acronym for “Registered Retirement Savings Plan” and yes, you might have guessed it – an RRSP is meant for saving for retirement!
As we are in an age where pensions are no longer as prevalent, most Canadians have to work hard and save for their retirement themselves and many do so through the use of an RRSP.
This is a tax-advantaged account. This means that it allows you to contribute to your RRSP and the amount that you do contribute will be exempt from your total taxable income for the year that you make the contribution. These contributions will only be taxed when you eventually withdraw the funds. With that said, a key benefit of this type of account is that it allows you to reduce your total taxable income for that year. This can make a significant difference depending on the tax bracket that you are in.
How Does this Work?
An RRSP is easy to open and many financial institutions provide a multitude of options. Consider looking for an institution that charges low fees, allows for direct-deposits into the RRSP and requires no minimum contribution, so you can contribute when you’re ready and on your own terms.
To determine what you can contribute to your RRSP in any given year, it’s either 18% of your past year’s income or a maximum amount, whichever is smaller. In 2022, for example, the deduction limit is $29,210. Your RRSP contribution limit is specific to you as you may have a rollover from unused contribution room in previous years.
To calculate your RRSP contribution room, you will need to determine how much you previously contributed and the contribution limits for each of the years. 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 noted above, you can reduce your tax bill in the current year by contributing to this account. For example, let’s say you made $80,000 this year and you decide to contribute $10,000 into your RRSP. Now, when it’s time to pay your taxes this year, the CRA will treat your income as though you earned just $70,000. Nice, right? Well, don’t forget that this approach defers your taxes, so you will pay when you withdraw these funds in your retirement.
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.