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February 24, 2021 | By: Christopher Northey

The Ultimate Guide to the Canada RRSP and TFSA

Taxes | Saving Money | RRSPs

No matter what your current financial situation might be, it’s never too early (or too late) to start planning for your retirement. But what types of investments should you consider? Figure out if investing in an RRSP or TSFA is right for you. And if you have debt, learn how you can become debt-free faster, long before you enter your golden years.  

What are the Best Options for Retirement Planning?

Unfortunately, too many people neglect to start planning for retirement because of other financial priorities, such as paying down debt, or saving up for major purchases, like a new car or their first home. Even though paying down high interest debt should be your first priority, it’s also important to consider your future financial health and security.

Two of your best options to prepare for a comfortable retirement are Registered Retirement Savings Plans (RRSPs) and Tax-free Savings Accounts (TFSAs). RRSPs are especially important because of their tax advantages.

What is an RRSP?

RRSP stands for Registered Retirement Savings Plan. This is an account that is registered with the federal government in which you can accrue large amounts of tax-free savings.

Canada first introduced RRSPs in 1957 with a clear goal in mind: to motivate Canadians to put money aside for their retirement years.

How Do RRSPs Work?

An RRSP is a tax-advantaged account. This simply means that the Canadian government provides tax breaks to those who invest in RRSPs. Think of this as a tax deferral. In other words, you do not pay the Canada Revenue Agency (CRA) any taxes on the income your RRSP earns every year.

The contributions you make to your RRSP are tax deductible, and as such, are used to reduce your annual taxes. You do not have to pay taxes on the money you save in your RRSP until you withdraw it.

For example, if your income is $50,000, and you contributed $10,000 towards your RRSP, your taxable income would be $40,000 for that year.

However, if your income was $50,000 and you withdrew $10,000 from your RRSP, your taxable income would be $60,000 for that year.

4 RRSP Benefits

What are the benefits of saving money in an RRSP in Canada? There are plenty of obvious advantages to contributing to an RRSP account. These include:

1. Your Contributions Are Tax Deductible

The amount of money you contribute to your RRSP reduces your taxable income. Therefore you save every year by paying a smaller amount in taxes.

2. You Can Grow Savings Fast

Whatever income you earn on non-registered investments is taxed. However, you do not pay any taxes on the income your RRSP earns year by year, including interest, dividends, and capital gains. Therefore, your savings grow quickly, by compounding interest over an extended period of time.

3. You Can Borrow From Your RRSP without Interest

You could withdraw from your RRSP as a loan. For example, if you are a first-time home buyer you can borrow up to $35,000 for a down payment, then repay it over 15 years, without any interest or taxes. The full amount will have to be repaid within 15 years. However, if you do not make your payment as scheduled every year, the amount you were supposed to repay yearly will be added to your annual income, which will taxed.

4. Your Tax Deferred Account Could Put More Money In Your Pocket

Even though your RRSP contributions and your investment earnings will be taxed when you withdraw them from your RRSP, your marginal tax rate will likely be lower in retirement, therefore the tax liability you have when you withdraw funds from your RRSP will probably be lower than the taxes you would have paid during your contributing years. In other words, because it is assumed you will be earning less income once you retire, your tax rate will not be as high as when you were working on a regular basis. Therefore, when you withdraw funds from your RRSP in your retirement years, you will not pay as much in taxes.

3 Types of RRSPs

There are a few common types of RRSPs you can open:

1. Individual RRSP

This is an account that is registered in your name, where all of the investments, along with the tax advantages, belong to you alone.

2. Spousal RRSP

This kind of account is registered in the name of your spouse or common-law partner. The advantage of having a spousal RRSP is if your income is higher than your partner’s. That way you can contribute directly to your spousal RRSP account and still receive the tax deductions during your contributing years. Then, when your partner retires and withdraws the funds, they pay less taxes than you would have.

The benefit of opening a spousal RRSP in Canada is to equalize your retirement income while minimizing taxes. However, if your spouse will be making about the same income as you do when you retire, this kind of account is of little benefit.

To enjoy the true advantages of a spousal RRSP, the combined income tax you would pay as a couple should be lower than what you would pay if you had all of your investments held in an individual RRSP.

3. Employer RRSP

Also referred to as a group RRSP, this kind of account is similar to an individual RRSP. The difference is that you contribute to it directly through your employer. Employers typically hold all employee RRSPs in the same financial institution; however, this isn't always the case.

Usually, employer RRSP contributions will be automatically deducted from your wages. Some employers will even match or add to your contributions (this is called employer RRSP matching) up to a certain percentage. Employers often cover the cost of opening and managing the plan as well, which is an excellent work benefit.

Contributing to an RRSP

The federal government enforces some rules on how you can contribute to and manage your RRSP account. The current limit you can contribute yearly is 18% of your income from the previous year or a maximum dollar amount stipulated in the current tax year. You are allowed to contribute whichever amount is smaller.

As of 2020, the maximum contribution limit dollar amount was $27,230, and in 2021, you can deduct up to $27,830. Given the recent trends, the contribution limit will likely increase each year. The CRA sets these limits in order to prevent excess contributions.

Withdrawing from an RRSP: Rules You Need to Know

Once you retire, it’s best that you withdraw the money from your RRSP gradually, both in order to make it last, and to pay minimal taxes. You could also withdraw money from your RRSP account before you retire, for example, to cover an emergency cost or to pay an overwhelming debt off faster. However, if you do so, you would face withholding taxes, which could be costly. Your RRSP provider would hold this amount and send it directly to the government on your behalf.

At the end of the year, you must declare any withdrawals as income on your tax return. Here is a breakdown of the withholding taxes you may face:

  • 10% for any withdrawals that are up to $5,000
  • 20% for amounts between $5,001 and $15,000
  • 30% for anything over $15,000

Note: Quebec applies provincial tax rates on top of the federal withholding tax. So if you live in Quebec, expect higher taxes on your RRSP withdrawals.

If you are in a locked-in plan, you are not allowed to borrow from your RRSP. If you are not sure what kind of plan you have, ask your provider.

Although the government withholds tax on your RRSP withdrawals, the amount may not be enough to cover all the taxes you owe when you file your return, and you could be forced to pay a significant amount more. Before you withdraw funds from an RRSP, be sure to consult with a tax professional, such as an accountant, to understand the tax implications specific to you.

How to Withdraw RRSP Funds without Tax Penalties

What's the best way to withdraw money from RRSP accounts without tax penalties? There are two circumstances that allow you to make early withdrawals without incurring withholding taxes.

1. The Home Buyers’ Plan (HBP)

As mentioned previously, the federal government allows you to borrow up to $35,000 from your RRSP to be used for building or buying a home. If you are purchasing a home with someone else, they can also withdraw up to $35,000 from their RRSP, for a total of $70,000 to be used as a down payment. Anyone can qualify for this program if they have not owned a home in the past five years, or occupied a home that their current partner owns.

This plan also enforces a repayment period. You must repay the amount borrowed within 15 years.

2. The Lifelong Learning Plan (LLP)

Through a Lifelong Learning Plan (LLP), you are allowed to withdraw up to $10,000 per year, up to a maximum of $20,000 to pay for full time education, either for you, your spouse, or your common law partner. Repayment is required within 10 years after your initial withdrawal.

How to Open an RRSP

You can set up your RRSP with a few simple steps.

Step 1: Find a Plan That Fits Your Needs

Once you understand the different types of RRSPs and how they work, shop around. Contact banks and other financial institutions, such as credit unions, trust, or insurance companies to ask about the investment options they provide and how they structure their fees, so that you are aware of the true cost of managing your account.

It is best to find an RRSP provider who charges minimal fees, provides plenty of support, and requires no minimum investment. Then start saving.

Step 2: Determine Your Investment Options

There are numerous ways you can invest in an RRSP, and which way is best for you will depend on a few different factors:

 1. Your Age
Generally younger people will be willing to accept more risk on their investments, in exchange for higher returns, as they will not need to access the money for many years. Older people will need to take less risk, as they will need the money sooner and may not be able to tolerate the inevitable ups and downs of the financial markets.

2. Your Ability to Take Risks
Higher risk investments usually earn more money over time, however their value can increase or decrease rapidly, especially during turbulent times. If you are uncomfortable with losing money on an investment, even temporarily, you should consider something less risky.

3. Your Need for Funds
Planning to purchase a home in the immediate future? If you want to borrow from your RRSP, it’s best to choose a safe, low risk investment. You do not want to risk losing money on your investment when you’ll need it most. It’s never wise to invest in something risky if you plan to use the money in the immediate future. If you think you will need the money soon, an RRSP may not be the best investment option. In that case, a better choice might be a Tax-Free Savings Account (TFSA).

4. Your Income Level
An investor with a higher income can afford to take more risk, especially if they will not need the money in the foreseeable future. An investor with a lower income will likely want a less risky investment, as they cannot afford to lose money during an economic downturn. Also, a lower income investor may derive very little benefit from only minimal tax savings and could be penalized if they need to withdraw money from their RRSP for an unforeseen emergency. Finally, a lower income earner derives more benefit from other investment options, such as TFSAs, which will be discussed later.

Step 3: Determine Your RRSP Investment Types

There are plenty of ways you can invest in an RRSP. It’s best to speak to a financial planner before deciding how and where to invest your money, and what type of investment might be right for you.

Different types of RRSP investments include:

  • Guaranteed Investment Certificates (GICs)
  • Mutual funds
  • Stocks
  • Bonds
  • Exchange Traded Funds (ETFs)
  • Savings accounts

Check your plan for any limitations on what type of investments you can make, as well as any costs or fees that may be involved. 

Step 4: Complete the RRSP Application

Once you decide where to open your RRSP account, simply follow the application instructions. You will likely need to provide photographic identification, as well as answer some questions concerning your investment strategy.

Then, simply open your account and let your savings grow. Remember to make your RRSP contributions before March 1st of the following tax year. For example, for the 2020 tax year, the deadline for RRSP contributions is March 1, 2021.

It’s always best to get started on retirement planning sooner rather than later. And if your employer offers an RRSP program where they match your contributions, take advantage of it as soon as you can. You can enjoy the rewards of compounding interest and watch your money grow over time.

To make things even easier, you can set up a process that automatically deposits RRSP contributions from your earnings (i.e., chequing account) to your RRSP account. This way, your money does all the heavy-lifting for you.

What is the Difference Between an RRSP and a TFSA?

An alternative investment option to an RRSP is a Tax-free Saving Account (TFSA). TFSAs were first introduced in 2009, and like an RRSP, income earned in a TFSA is not taxed. 

The main difference between an RRSP and TFSA is that your contributions to a TFSA are not tax deductible; however, there is no tax penalty when you withdraw money from your TFSA. This has made TFSAs very popular, especially amongst lower income earners who derive little benefit from the tax deduction of an RRSP.

The limit you can contribute to a TFSA for 2021 is $6,000. For those who have never contributed to a TFSA and were at least 18 years old in 2009, the maximum they can contribute in 2021 is $75,500. Once you have reached your maximum contribution, the only penalty you will incur if you withdraw any amount from your TFSA is that you must wait a year to recontribute that amount to your TFSA.

Investment experts usually recommend you maximize your TFSA contributions before contributing to an RRSP, unless you need the immediate income tax deduction savings. It’s best to consult with a financial expert to weigh these options, and to create a well-thought-out investment plan that works best for you, your current financial situation and obligations, and your future goals.

How Credit Canada Can Help You Plan for Retirement

No one wants to retire with debt (especially if you have high-interest debt). By helping you become debt-free faster, such as with a Debt Consolidation Program, we can help you start saving more money for your future sooner, and enjoy your retirement years debt-free.

At Credit Canada, we believe in providing a holistic approach to personal money management and debt management. If you have unsecured debt and would like to start building up your retirement savings, we can help you explore your different debt relief options. Simply book a free Debt Assessment with us!

Our certified Credit Counsellors can also take a look at your budget and tell you how much money you have to start putting towards an RRSP and/or TFSA, and how long it would take you to build the nest egg of your dreams. All of our counselling is 100% free, confidential, non-judgmental, and there’s absolutely no obligation. 

Regardless of how you decide to invest your savings, the sooner you start investing in your future and retirement, the sooner you can begin to build your nest egg. Do your research and decide what options suit you best by examining the advantages and disadvantages of each. A well-executed plan can result in a financially successful and comfortable future. For free, unbiased, and confidential advice, call 1.800.267.2272.

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