Registered Retirement Savings Plan
A Registered Retirement Savings Plan is an investment account designed to save for your retirement. They were first introduced in 1957 along with the Canadian Income Tax Act. Similar to a TFSA you can hold various investments including stocks and Exchange Traded Funds (ETFs). There is no minimum age to open a RRSP however you do need to have claimed income in Canada in order to contribute. RRSPs must be converted into a Registered Retirement Income Fund, purchase an annuity, or any combination by age 71.
Certain income known as earned income generates RRSP room which includes the following: net employment and business income, disability payments from the Canada Pension Plan or the Quebec Pension Plan, royalties, net rental income, taxable spousal support, and separation allowances. Income that does not generate RRSP room includes: OAS, CPP, investment income such as dividends and interest, and amounts received from RRSP withdrawals. Contributions grow tax deferred until you withdraw from the account. Contributions are capped at the lesser amount of 18% of your previous year’s claimed income, subject to the limit set by CRA which for 2022 is $29,210.
If you withdraw from a RRSP there is withholding tax depending on the amount you withdraw unless you are withdrawing for the Lifelong Learning Plan or First Time Homebuyers Plan. The withholding tax will be deducted and remitted to CRA at the time of withdrawal. Withdrawals are also included in your annual income. Unfortunately withdrawal amounts cannot be added to future accumulation room as they can with TFSAs. For example if you withdraw $5,000 this year, that amount is not added to your contribution room for the following year.
The main benefit is contributions to a RRSP are tax deductible against your income. You may choose when to deduct your contributions against your income meaning you do not have to deduct against your income in the same year as you contribute. We’re always hesitant to give concrete numbers of when it makes sense to contribute to a RRSP versus a TFSA but we will say generally it is more beneficial to contribute when you are in a lower tax bracket and deduct when you are in a higher bracket. Additionally if you are concerned about paying taxes when it is time to file then it may make sense to contribute to your RRSP.
There are a few examples of when it may not be optimal to contribute to a RRSP. If your employer provides a well funded Pension Plan it may not be vital to contribute to an RRSP. Contributions via a Pension Plan also reduce your contribution room. If you will be in a low tax bracket during retirement, withdrawals from an RRSP or RRIF may lower income tested benefits. A third scenario would be if your tax bracket won’t materially change come retirement time. RRSP deductions are maximized when tax brackets differ over time. If they are relatively the same the benefits are decreased, although not eliminated. An example of this is a person that does not really plan to retire, or at least plans to work well passed typical retirement age. As always everyone’s circumstances are different so consult with a financial professional for specific advice.