This year is going to be different, you tell yourself.
You are going to:
- Eat healthy and work out five times a week.
- Read more books.
- Get your finances in order and start saving for retirement.
As the calendar turns into the second month of the year, you haven’t been to the gym in 2 weeks, the baked chicken has become a bag of chips, and the books are gathering dust as you watch a basketball game.
Despite the first two resolutions quickly falling by the wayside, the third resolution continues to nag you.
“I really do want to get my finances in order,” you think to yourself.
“Every other commercial seems to be from a financial institution. Investments. Savings. RRSPs.”
“I mean, what the heck is an RRSP?”
You are not alone. This is a question we get regularly.
To help you make sense of it all, we are rolling out a three-part series on all things RRSP this month on the blog.
This first post serves as a high-level overview of the RRSP. We will address five important questions about the RRSP, giving your knowledge on the subject a kick-start.
What is an RRSP?
A Registered Retirement Savings Plan (RRSP) is a type of investment account that allows you to reduce your current year’s taxable income while you save it for the future.
For example, if you make $60,000 in a year and make $7,000 in RRSP contributions, your taxable income will be reduced to $53,000.
You can contribute up to 18% of the earned income you reported on your tax return in the previous year on an annual basis. You can contribute a maximum amount ($29,210 in 2022), and any contribution room you do not use in a year can be carried forward to future years.
The general idea is to reduce tax in your higher-earning years. Tax on investment growth is deferred within the RRSP until the funds are withdrawn. Ideally, this occurs during retirement when you are in a lower tax bracket.
Are there different types of RRSPs?
Yes! There are three main types of RRSPs.
The most popular type is the Individual RRSP. In this case, an RRSP account is set up in your name, and you make all of the contributions. You also obtain all of the tax advantages (more on that in a bit). This is often set up with the assistance of a financial advisor or financial institution. A more DIY version of the Individual RRSP is the Self-Directed RRSP. The individual chooses which investments to hold in their account and makes all of the buy-and-sell decisions for themselves.
If you have a spouse, another option is the Spousal RRSP. Here, one spouse (typically the one who earns more) contributes to the spousal RRSP. The contributing partner gets the tax deductions, and their spouse becomes/is the owner of the account. Think about this in hockey terms – the contributing spouse is getting the assist instead of the goal!
The main advantage of this strategy is twofold:
- The higher-earning spouse gets to reduce their taxable income in the year of contribution.
- It allows couples to split their income in retirement, which reduces their overall tax bill.
We will explore the Spousal RRSP in greater detail in a future post, as there tends to be some confusion around it.
Finally, your employer may offer a Group RRSP as a benefit of employment. These are advantageous for several reasons:
- Matching provisions in the plan where the employer matches some or all of the employee’s contributions.
- Contributions are made directly by payroll deduction on a pre-tax basis, which immediately reduces your tax burden.
- Lower management fees than typically available for individual accounts.
Can I have more than one RRSP?
Absolutely. Many Canadians do have more than one.
However, it’s important to remember that your overall RRSP contribution limit remains the same, regardless of whether you have one RRSP account or numerous.
What can I invest in?
A wide array of qualified investments can be used in an RRSP. These include mutual funds, segregated funds, stocks, bonds, Guaranteed Investment Certificates (GICs), Exchange Traded Funds (ETFs), and others.
The Canada Revenue Agency (CRA) has a handy guide listing all qualified investments.
I keep hearing about the RRSP deadline. What does that mean?
It’s important to note that RRSP contributions can be made at any time throughout the year. The corresponding tax deduction can be claimed for the current year or carried forward to future years.
There’s also a 60-day window at the beginning of the year, where contributions can be applied to last year’s income.
The RRSP deadline refers to the last day that RRSP contributions can be made to reduce your tax bill for the previous year. The 2022 RRSP deadline is March 1, 2022.
Now that you know the basics of the RRSP and how they work, we can move up a level. In our next post, we will look at the advantages of an RRSP and provide tips on how you can get the most out of it.
Please join us.