What is an RRSP? A Comprehensive Guide

As a Canadian, there are several retirement plan options available.

None provide as many tax benefits as the registered retirement savings plan (RRSP). It's also quite simple to understand.

Often called the superhero of modern retirement planning, an RRSP should be a part of everyone’s retirement strategy. Find out how it can help you meet your long-term financial goals.    

What is an RRSP?

Registered with the Canadian federal government, an RRSP is a tax-advantaged account that helps you save for retirement. 

To be eligible for an RRSP, you must: 

• Be a resident of Canada and have a valid Social Insurance Number (SIN)
• Have employment income
• Have filed income tax

There is no minimum age requirement to open an RRSP account, but some providers require you to be the age of majority (18 in most provinces). Despite its name, an RRSP is more than a savings account. Apart from cash, it can hold various income-generating investments, including stocks, mutual funds, bonds, guaranteed income certificates (GICs), etc. 

Your RRSP contribution are deducted from your taxable income for the year. Also, any capital gains earned on investments held in an RRSP grow tax-free, until you withdraw the funds. 

You can contribute to an RRSP until the last day of the year you turn 71, but can take money out before that if you want. While all RRSP withdrawals are taxed, early withdrawals are subject to tax penalties. 

You can open an RRSP with a bank, trust company, credit union, mutual fund company, life insurance company, or investment firm. 

Key Takeaways

• The RRSP is a savings and investment vehicle for Canadian residents who have earned income and filed income taxes.
• RRSP contributions are tax-deductible and all of your capital gains grow tax-free while they remain in the account.
• RRSP withdrawals are subject to tax.
• RRSPs have annual dollar limits, called contribution room. For 2023, you can contribute 18% of the previous year’s income or $31,560 (whichever is less).
• The unused contribution room rolls over to future years.
• Your RRSP matures by December 31 of the year in which you turn 71.

How does an RRSP work?

Now that we know what an RRSP is, let’s look at how it works and how to start saving.

Step 1 – Open an RRSP

You can open an RRSP with financial institutions of your choice and start saving for retirement. Like other registered savings vehicles, the RRSP can hold various assets. Qualified investments include cash, GICs, ETFs, mutual funds, bonds, and more. 

Step 2 – Make contributions 

Each year you can contribute the lower of: 

• 18% of your previous year’s income
• the annual contribution limit for that year (For 2023, the annual contribution limit is $31,560)

Let’s say your gross income in 2022 was $60,000. So for 2023, your calculation would be: 18% of $60,000 or $31,560, whichever is lower. Let’s do the math: $60,000 x 18% = $10,800. Since this is less than the annual limit, your 2023 deduction limit for RRSP is $10,800. 

However, if you do not use the entire contribution room in one year, the unused contribution room gets carried forward into future years. 

Continuing with the above example, let’s assume your deduction limit in 2022 was $10,000. However, because of an unexpected expense, you could only deposit $6,500. This left you with $3,500 in unused contribution room, which you can use in 2023. 

So in 2023, you can contribute a total of $14,300 ($10,800 + $3,500) in your RRSP. 

Make withdrawals after retirement

Your RRSP accounts matures the year you turn 71. By then, your tax rate would likely be lower, which means the money you withdraw would be taxed at a lower rate than when it was first contributed to your account. 

Of course, you can withdraw money before your account matures. But if you do so, you will have to pay a tax penalty. The penalty you pay on early RRSP withdrawals depends on two factors: 

• The province where you live
• The amount of money you withdraw

How do you open an RRSP in Canada?

You can open an RRSP with a financial institution (e.g. a bank, insurance company, trust company, or credit union) of your choice. Before opening an account, consider the types of RRSPs offered by selected financial institutions, your risk tolerance, and the types of investment products you want to hold. Once you have found the right plan, fill out the application form and start making deposits directly into your account. 

You do not have to be of a certain age to open an RRSP. As long as you have employment income and filed a tax return, you can set up an account. However, if you are a minor, you will require the consent of a parent or guardian. 

What are the different types of RRSPs?

Individual RRSPs

An individual RRSP is a retirement savings plan that you contribute to and that is registered in your name. You own the investments in the plan and enjoy all the tax advantages associated with it. 

Depending on your comfort level with investing, you can create an RRSP strategy that is right for you. For example, if you want to choose your own investments, a self-directed RRSP is a good option. While it requires considerable commitment, a self-directed RRSP allows you to build your portfolio from a large pool of investment products and has lower fees. But if you lack the time or are not comfortable wading through a sea of investment products alone, you would be better off with a pre-built RRSP portfolio. 

Spousal RRSPs 

Do you and your spouse or common-law partner want to reduce your combined tax burden? If so, spousal RRSPs might be the solution. 

Spousal RRSPs allows you to make contributions to your spouse’s or partner’s RRSP, up to your personal annual limit. By doing so, you can split the retirement more evenly between yourself and your spouse or partner, lowering your combined tax liability. 

RRSP withdrawals are taxed at your individual income tax rate. Splitting your RRSP income with your spouse during retirement can be advantageous. It allows you to leverage lower marginal tax rates by distributing the income to the spouse who will be in a lower tax bracket when both of you retire. Simply put, your tax liability is lower on two incomes of $40,000 than on one income of $80,000.

Available to married couples and common-law partners, spousal RRSPs is a good option when one spouse earns significantly less than the other. For example, you may want to consider it if your spouse is presently a homemaker while you are employed full-time. 

Like a traditional RRSP, spousal RRSPs grows money on a tax-deferred basis and matures on the last day of the year when the account holder turns 71. However, it also has several unique features. Knowing about them in advance will help you determine if a spousal RRSP is right for your family. 

• You contribute to your spouse’s RRSP and claim a tax deduction, but your spouse — not you — owns the investment held in the account. 
• The RRSP accounts is registered in your spouse’s name.
• The amount of money you contribute to your spouse’s RRSP and your own RRSP in one year cannot exceed your annual deduction limit. Let us say, your RRSP deduction limit for 2023 is $10,000. You decide to contribute $3,000 to your spouse’s RRSP. This means you can only contribute $7,000 to your own RRSP in 2023.   
• If your spouse takes out money you have contributed within the first three years of the contribution date, you will pay tax on that sum. After three years of the contribution date, your spouse will pay tax on the withdrawn amount.

Group RRSPs

A group RRSP allows you to build a nest egg for retirement through regular salary deductions. The plan is registered in the name of the employee, but generally both the employee and employer contribute to it. Certain conditions regarding withdrawal apply, which can vary by employer. 

Here are some of the unique features of Group RRSP: 

• You set up an individual RRSP with a financial institution selected by your employer. (All employees of a company have their RRSPs with the same provider)
• You contribute to your plan through regular salary deductions. Your employer may match a fixed percentage or all of your contributions. 
• The employer generally bears the costs associated with the opening and managing of the RRSP. The employee pays the investment costs (if any).
• Group RRSP have more limited investment options than individual plans.
• Certain conditions regarding withdrawal apply (e.g. you may not be allowed to make a withdrawal until your account has been in existence for a specific period). 

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How much you can contribute to RRSPs?

The maximum amount you can contribute to an RRSP in a calendar year is 18% of your previous year's income or the current year's annual limit, whichever is less. 

What are the benefits of an RRSP?

Saving money in an RRSP can be about more than just reducing your taxable income and creating a source of retirement incomes. There are many RRSP benefits to know so that you can make the most of them. 

1. Contributions are tax-deductible

You can deduct RRSP contribution against your income. This, in turn, reduces your tax bill during the contributing years.

Let’s say you earn $80,000 a year and want to contribute the maximum amount allowed to your RRSP accounts in 2023. Assuming you earned $80,000 in the previous year and had no unused contribution capacity, your maximum contribution is 18%, or $14,400. When you file your taxes, you can deduct this amount from your income. As far as the CRA is concerned, you made just $65,600. Of course, the CRA will eventually collect taxes when you withdraw funds, but by that time you will be retired and almost certainly in a lower tax bracket. 

2. Returns on investments are not taxed until withdrawn

Any investment or interest earnings made on the money inside an RRSP are not taxed while it remains inside the account. This means your RRSP funds will grow faster because they are not reduced by taxes each year. 

3. A spousal RRSP can minimize your combined tax burden 

If you make significantly more money than your spouse or common-law partner, you can help them build their own tax-deferred retirement fund by contributing to a spousal RRSP. This will ensure the retirement income will be split more evenly between you two, besides reducing your combined tax liability. 

4. Unused contribution room rolls over

Can't use all of your RRSP contribution room this year? Don’t worry, you will not lose the unused contribution space. Instead, it carries forward to future years. When you have more money, you can make a larger contribution to catch up.

5. Plenty of investment options

Think of an RRSP as a basket into which you can put various investment products. Examples of qualified investments include: 

• Cash
• Stocks
• Bonds
• Mutual funds
• Treasury bills
• Exchange-targeted funds (ETFs)
• Guaranteed investment certificates (GICs)

6. You can withdraw without paying taxes in certain situations

You can withdraw funds from your RRSP accounts without paying taxes for buying your first home or financing your education, provided you pay the money back within a certain time period. 

With the Home Buyer’s Plan, you can withdraw up to $35,000 to make the down payment for your first house without paying taxes. You must repay the money within 15 years. 

Under the Life Learning Plan, you can take out a maximum of $20,000 to cover education costs for you or your spouse or your common-law partner. You must pay back the funds within 10 years. 

7. You can use an RRSP to purchase an annuity or fund an RRIF

You can hold on to your RRSP till the last day of the year you turn 71. After that, you must withdraw the RRSP benefits by either: 

• Taking a lump-sum payment
• Converting your RRSP accounts to an RRIF
• Purchasing an annuity

Conclusion

A registered retirement savings plan (RRSP) is a simple method to save for retirement. You put funds into your RRSP and get a tax break. Then, the deposited funds and investment gains grow tax-free inside the account. When you retire, you can take out the money and it becomes part of your taxable income.

You can set up an RRSP through a financial institution such as an insurance company, a traditional brick-and-mortar bank, a credit union, or an investment firm.

Frequently Asked Questions

What is the RRSP good for?

The RRSP is a retirement savings vehicle and helps you grow your money faster. Making an RRSP contribution may help reduce the total amount of tax you pay and all of your investment income grows tax-deferred. 

What is the most common type of RRSP?

Most people opt for an individual RRSP. Other common RRSPs include a spousal RRSP and a group RRSP. 

At what age can you withdraw from RRSP without penalty? 

Your RRSP matures on 31^st December of the year you turn 71. At this point, you must withdraw the funds. You do not pay tax penalty when you withdraw money after your RRSP account has matured. However, the withdrawn amount will still be subject to tax.

What is a Registered Retirement Savings Plan (RRSP), and how does it differ from a Registered Retirement Income Fund (RRIF)?

A Registered Retirement Savings Plan (RRSP) is a savings plan with tax advantages that allows individuals to contribute pre-tax income to save for retirement while benefiting from tax savings and reducing income tax. Contributions made to an RRSP are deducted from taxable income, providing immediate tax benefits and enhancing overall tax savings. On the other hand, a Registered Retirement Income Fund (RRIF) is created by converting an RRSP after retirement, and it provides regular income payments during retirement, with the added benefit of potentially lowering income tax. Both serve as valuable tools for retirement planning and have different roles at various stages of one's financial journey.

Can I contribute to both a Registered Retirement Savings Plan (RRSP) and a Tax-Free Savings Account (TFSA)?

Yes, you can contribute to both an RRSP and a Tax Free Savings Accounts (TFSA). Each account has its unique tax advantages. While RRSP contributions are tax-deductible, meaning they can be claimed on your tax return, TFSA contributions grow tax-free, making them both valuable components of a comprehensive retirement savings strategy.

How does the Canada Revenue Agency (CRA) determine the contribution limit for Registered Retirement Savings Plans (RRSPs)?

The Canada Revenue Agency (CRA) sets the RRSP contribution limit based on an individual's earned income from the previous year. The RRSP contribution limit is subject to an annual maximum set by the Canada Revenue Agency and is usually indexed to inflation. Keeping track of your RRSP contribution limit is vital to make the most of your RRSP's tax benefits.