What is an RRSP and How Does It Work?

March 15, 2021

rrsp

What is an RRSP?

Registered Retirement Savings Plan (RRSP) is a retirement savings account. Individuals can contribute up to their contribution limit.

Amounts contributed are deducted from taxable income, reducing your taxes payable for the year. So if you earned $100,000 in a year and contributed $10,000 then CRA will only tax you on $90,000 in that year. Any gains in the account are tax-deferred. This does not mean that there is no tax on the amounts contributed. Taxes are deferred until funds are withdrawn from the account.

You can start contributing at any age up until you turn 71. If you haven’t started contributing then you should consider contributing as soon as possible. This will allow you to earn income on contributed amounts for a longer period.

How does an RRSP work?

RRSP’s can hold a wide range of investments. They can include:

    • Cash
    • GIC’s
    • Mutual Funds
    • ETF’s
    • Bonds
    • Equities
    • Treasury Bonds
    • Savings Bonds

Depending on the investment, the downside is that the value of investments can fluctuate which means they can go down as well as up. 

What is the RRSP contribution limit?

The contribution limit is the maximum amount you can contribute in the year. It will be stated in your Notice of Assessment. The contribution limit for 2021 is $27,800.

Your contribution limit is calculated as the lessor of, contribution limit for the year and 18% of your income earned in the previous year.

What happens if I don’t use my contribution limit?

Unused contribution in any year is carried forward to the next year allowing you to catch up and use it when you are able to. Therefore, your unused contribution limit is added to the following year.

Benefits of RRSP 

    • Any amount contributed is deducted from your taxable income, thereby reducing taxes payable for the year.
    • Amounts contributed are not taxed until withdrawn. 
    • RRSP savings can be used to pay for education (Lifelong Learning Plan) or used as down payment for purchase of your first home (Home Buyers’ Plan).
    • You are allowed to use your contribution limit towards your spouse RRSP.

What if you overcontribute to your RRSP?

CRA provides a $2,000 buffer, this means that CRA will not impose any penalties up to this amount. You will receive a letter informing that your have overcontributed and action is required. If you don’t take action then there is a penalty of 1% per month on over-contribution.

Withdrawing from RRSP

When you withdraw funds, the amount withdrawn will have to be included in your income reported to CRA. Therefore, it will be taxable.

However, if you withdraw funds for first time home purchase (Home Buyer’s Plan) or for paying for education (Lifelong Learning Plan), then there is no tax payable. This condition is only applicable if you put the funds back into your RRSP within a certain period.

Home Buyer’s Plan allows you to withdraw $25,000 from your account and your spouse can withdraw the same amount.  

Lifelong Learning Plan allows you to withdraw up to $20,000 to pay towards your education.

Where can you open an RRSP?

You can open it in Banks, Credit Unions, Investment Firms, Trusts, and Insurance Companies.

Registered Retirement Savings Plans are a great way to save towards your retirement. As the name suggests this plan is for retirement which means it is a long-term investment. While this is a long-term strategy, there is a short-term benefit, it allows you to reduce your taxable income. You may think you are too young to think about retirement but the earlier you start, the longer your money can grow in this account.

Related Articles

What is the Importance of Saving Money?

What is the Importance of Saving Money?

The importance of saving money should not be taken lightly considering the role it plays in achieving financial stability. Saving is basically when you spend less than you make, the money left over in your savings. Whatever may be your financial situation, saving...

How to Save for Education

How to Save for Education

Save for Education You will hear over and over Save for Education, that’s because paying for education can be daunting, be it your own or your child’s education. Many people don’t realize that saving for education is possible if done right. As a general rule, you...

7 Money Saving Tips

7 Money Saving Tips

Money Saving Tips  Here are 7 money saving tips to get you started on the path to saving. Set-up automatic savings  Saving through automatic savings is an easy and convenient way to save. To set-up automatic savings, instruct your bank to take a certain percentage...