March 1, 2021 is the deadline for contributing to an RRSP. Doing so will lower your income tax bill for 2020 while helping you save for retirement (bless). If you’re wondering, WHAT?! HOW?! Read on.
What Is An RRSP?
A Registered Retirement Savings Plan (RRSP) is an account introduced by the Canadian government in 1957 to help Canadians save for retirement. It has since expanded its programs to include an RRSP Home Buyers’ Plan (HBP) and an RRSP Lifelong Learning Plan (LLP), which were designed to help Canadians save for a first-home down payment and continued education respectively. RRSPs are “tax-deferred,” meaning any money you contribute will be exempt from CRA taxes the year you make the deposit, and will only be taxed years down the line when you withdraw it. The main benefit of RRSPs is that tax on RRSP contributions is deferred until retirement (a time of life when you’re subject to much lower tax rates). In short, RRSPs are an amazing way to cut down a current-year tax bill.
Who Can/Should Open One?
There are two types of people for whom an RRSP is ideal:
- Those who are saving specifically to buy a house
- Those who make more than $50,000 per year and are focused on saving specifically for retirement
Note: If you make less than $50,000 per year and are focused on retirement, you may want to look into opening a TFSA account instead.
The only conditions for eligibility are that you are under 71 years of age, are a Canadian resident for tax purposes, and file income taxes in Canada. Minors under the age of 18 can set up an RRSP with written parental consent (or that of a legal guardian).
How Do You Open One?
Opening an RRSP requires very little time and energy and can easily be accomplished from the comfort of your own home. You’ve got tons of choices of institutions wherein you might open an RRSP account, but we personally prefer Wealthsimple.
The benefits of using Wealthsimple
Low cost: Wealthsimple’s fees are just a fraction of what most investment managers charge.
Track your contributions: The CRA’s rules are confusing. Wealthsimple keeps track of all your contributions so you won’t have to.
Smarter, personalized portfolios: Using Nobel Prize winning strategies and cutting-edge technology, they’ll create the perfect portfolio mix to maximize returns while minimizing risk.
Invest in your values: Wealthsimple offers Socially Responsible Investing, so you can do well and do good at the same time.
How Do Deposits Work?
Because RRSPs are registered accounts, they’re subject to certain rules. One of the most important rules concerns the amount of money you can contribute to the account in any given year; it’s either 18 percent of your past year’s income or a maximum amount, whichever’s smaller. (For reference, in 2019 the limit was $26,500. In 2020 the RRSP deduction limit was $27,230—the amount may increase annually.)
You can also catch up if you didn’t max out your investments in earlier years; to find out how much you can contribute, check out the Notice of Assessment you got after filing your taxes last year.
It’s important to remember that even though you might have contribution room left over from previous years, you will not accumulate deduction limits.
How Do Withdrawals Work?
Depending on the kind of RRSP owner you are (retiree or homebuyer), withdrawals will work in one of two ways:
- For an RRSP withdrawal by a retiree: When you retire, your RRSP turns into a Registered Retirement Income Fund (RRIF) that you can withdraw money from (income tax would apply to any withdrawals). If you die, however, your RRSP is usually rolled over to a beneficiary on a tax-deferred basis. (Remember that will we told you to make a while back? If you open an RRSP—or any tax sheltering account, for that matter—you’ll want to add a note on who you’d like to be the beneficiary for that account in case you croak; if no beneficiary has been named, then the proceeds from your RRSP are considered part of your estate and will be distributed accordingly).
- For an RRSP withdrawal by a homebuyer: The RRSP Home Buyers’ Plan allows eligible first-time homebuyers to withdraw up to $35,000 tax-free from their RRSP to be used toward a down payment on the purchase of the home. To withdraw funds, first you’ll need to fill out form T1036. This is called the “Home Buyers’ Plan (HBP) Request to Withdraw Funds from a RRSP.” You should submit this form to your financial institution to let them know your intention to withdraw funds. It’s not possible to withdraw the money from your RRSP and then claim it was part of the Home Buyers’ Plan, so make sure to do it the right way! Note that it’s very possible to make multiple withdrawals under the Home Buyers’ Plan in the same year, provided you don’t exceed the $35,000 limit.
It’s important to note that The Home Buyer’s Plan is structured in a way that you’re basically loaning yourself money for a house and because of that, it comes with a hell of a lot of rules – rules with great tax implications that you’ll definitely need to follow. If you’re planning to purchase your first home sooner rather than later, you may want to consider a more accessible account. A TSFA might be the wiser choice since they’re a lot more lenient about withdrawals than RRSPs.
Whether you’re using the funds in this account for retirement or to help you with a down payment on your first home, you may be wondering just how much you will have made on your investment when it’s time to withdraw. What you should know is that the value of your RRSP depends on how much you’ve contributed each year, what assets your RRSP is invested in, and how many years you’ve had the account for. However, average rates of return for retirement accounts tend to hover between 4 and 8 percent.
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This post is an adapted excerpt from our latest book:
Get Your $hit Together: The Rebel Mama’s Handbook for Financially Empowered Moms.
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