Disclaimer: I am not a financial or tax advisor. You are trading at your own risk and should consult a financial advisor and/or tax advisor for any investment decisions. Do your own due diligence when considering investing, and this information is for education/informational purposes only. The article “What Is An RRSP? Decrease The Scary Taxes You Pay” serves as educational content, not investing or tax advice.
You’ve probably heard of an RRSP through maybe some coworkers or through your friends.
The truth is an RRSP like a TFSA is one of the most popular Canadian investment accounts that you can register for.
The question is should you register for this RRSP? What are the benefits of doing so? Can it benefit your personal income tax at the end of the year?
These questions, along with others, will be my objective to answer throughout this article today.
If you like articles like these, please let me know below in the comment section and gear in for a lengthy article.
What is an RRSP?
Let’s start from the very beginning. Allow me to assume that you do not know what an RRSP is, and it’s basically like a foreign language.
RRSPs, better known as a registered retirement savings plans, is a government-registered account that allows you to defer paying taxes on your investments until later in life. This in turn allows you to make your contributions tax deductible. Yes, I did say tax deductible. Technically, it reduces the amount of tax individuals will owe on their personal income tax returns.
While your eyes may be widened, let’s discuss this further.
How does an RRSP work?
To be eligible to open an RRSP, there’s actually no minimum age limit like there is for a TFSA. Once again, what you will need, though, is a social identification number and a bank account if you do not already have those.
But the only issue maybe for a young individual would be the amount they can contribute to the account. There is a yearly contribution limit, but it’s calculated differently than for a TFSA which I will discuss below.
The entire idea and concept of an RRSP are that you take your pre-tax dollars and put them into this account, allowing you to take advantage of claiming your contributions on your personal income tax returns.
Yes, once again people, that means that it is a deduction on personal income tax returns.
Yet, there’s another side to it.
While you can make these deductions whenever you contribute to the account, any income generated is immediately taxed when you decide to withdraw money from this account.
So, when I’m saying income, this could be your capital gains, interesting come, dividends, etc.
Now, if you’re not familiar with calculating your taxable capital gains, I suggest you take a look at my article on how to invest in Canada. There is a section dedicated to where I break that down.
To sum up the whole idea of an RRSP, you may use it to pay fewer taxes now and hopefully pay little tax later in the future while you let your earnings grow over a long period.
RRSPs for non-residents:
Can non-residents of Canada open and contribute to an RRSP account? The answer to this really isn’t as straightforward as it is for a TFSA.
In some cases, depending on your ties to Canada, any income earned through the RRSP may need to be declared as earned income on your personal income tax statement.
However, there seem to be some forms that you could fill out to help get you to claim the contributions as deductions and personal incomes tax statements. However, the answer to that seems to remain in the air.
The answer that I’m going to provide you with this question is to speak to a local accountant. If you have social ties within Canada but maybe work abroad, you won’t be able to make future contributions because the income is not Canadian-based. It’s foreign.
If you were a student studying with Canada and works within Canada, my assumption and the keyword there is my assumption here is that you would be able to hold an RRSP and contribute to it with the Canadian earned income you make.
But speaking to an accountant will allow you to:
- Fully understand whether you can contribute to an RRSP depending on your situation. and
- Will help you find and fill out some of the forms needed to either contribute or deduct contributions on your personal income tax statement.
RRSP first 60 days:
I had no idea initially that there were specific guidelines surrounding contributions to an RRSP.
My general assumption was that you open one up, deposit some money, and then you proceed to invest or gain interest on your money.
However, for tax purposes, there are two periods that you shouldn’t take note of.
Contributions you can deduct on your personal income taxes are from March 2nd to December 31st of the current tax year.
The second period you want to get noted is from January 1st to March 1st of the following tax year.
The Canadian government has said these two periods up in this way. For more information relating to current your due dates meaning 2021, check the link here.
The nice thing about having an RRSP is the fact that you can have a spousal RRSP. This is an investment account that is either registered in your or your common-law’s or spouse’s name.
So, I’ll just go into very brief detail on the spousal RRSP. Two people can contribute to one RRSP account.
For example, if you have Joey and Amanda, who both have RRSPs, Joey can contribute to Amanda’s RRSP, but there’s no general RRSP that contains just one account for both of them.
While Joey may be able to contribute to Amanda’s RRSP, the contributions come out of his own RRSP. So, for example, if Joey was able to contribute a total of $20,000 to his RRSP and contributes half of that to Amanda’s, the remaining amount he can contribute to his own RRSP is the other $10,000.
Another benefit of the RRSP is if Joey has turned 71, but Amanda is 66. As we traditionally know, Joey cannot continue to contribute to his RRSP given his age. However, you can contribute to Amanda’s RRSP until she turns 71 as well.
So, does this mean the other person, Amanda, can contribute her annual contribution limit in additional to Joey’s contributions?
No, it does not seem that way. Amanda would not contribute the additional amount from her annual contribution limit in the given tax year.
The spousal RRSP is really designed to help pay less taxes. If one spouse earns a higher income yearly than the other, they can potentially save the amount of tax they’ll have to pay whenever they turn 71 or start to withdraw if they can contribute to the other spouse’s account.
Having Multiple RRSP accounts:
Yes, I do believe that you can actually hold multiple RRSP accounts at once. It’s similar to a TFSA where you can also have numerous TFSAs at your desire.
The reasoning behind having multiple RRSP accounts is basically to be more organized.
Goals with your RRSP may not be one goal but instead multiple.
Maybe you want an RRSP dedicated to retirement income, a down payment on a house, and a brand-new Porsche.
Your reasons clearly don’t need to all be the same, and if you feel more organized in having just one RRSP, you certainly can just hold the one.
Are RRSP contributions tax-deductible:
The simple answer here is yes. The contributions you make to your RRSP are indeed tax-deductible.
So hypothetically, what would that look like?
Let’s look at the example provided below.
Here we have Serge. Now Serge annually makes around $60,000 from his employer. Another $10,000 comes from his self-employed business.
However, this year is the first in Serge’s life that he will open an RRSP and start contributing to his long-life goal of opening a stonk masterclass.
Serge decides to contribute $5,000 into his RRSP account so he can make 10000% returns over the next couple of years and finally craft his masterclass.
The calculation of the deduction is pretty simple. Here, despite the fact that we don’t know the RRSP contribution room Serge used to have, he currently has a $12,600 contribution room as calculated in the example (for more clarification, scroll to the dedicated section).
With that said, the deduction is equal to the contribution amount, which we know was $5,000. Overall, this displays that Serge would have less taxable income.
To illustrate the difference in the taxes he would pay, before tax credits, consider this calculation:
I based the provincial rates in New Brunswick.
By looking at it this way, by making a $5,000 contribution to his RRSP, Serge will not have to pay an additional $1,766.00 on his taxes!
Now that’s the power of the RRSP!
Are RRSP withdrawals taxable:
Any withdrawals you make from your RRSP are indeed taxed.
So, the amount you are taxed on does not depend on the type of income you ever earned.
The amount you withdraw from your account is added to your earned income. So, if you withdraw $4,000 from your RRSP, the $4,000 will be added to your earned income.
But what could be the most critical point of this section is that there’s a withholding tax rate. Yes, now a withholding tax rate is basically an amount that the government keeps from your withdrawals.
There’s a list of the withdrawal rates in each province and territory excluding Quebec and then another column for those including Quebec.
|Amount:||Withholding Tax Rate in Every Province and Territory Except Quebec:||Withholding Tax Rate in Quebec:|
|Up to $5,000||10%||5%|
|$5,000 up to $15,000||20%||10%|
So, for example, let’s say you want to withdraw $1,000 and live in Yukon. When you draw that $1,000, there is a 10% withholding tax rate. That means at the end of the day, you’re really keeping $900 of that 1,000.
It’s probably the worst side of having an RRSP, but at the same time, you’re contributing to the account to earn deductions now and worry about paying the tax later.
How RRSP withdrawals are taxed:
So, now that we have looked at how the contributions are deducted from taxable income, let’s turn to how a personal income tax return may be affected by a withdrawal.
I’ve already discussed the withholding tax, so we understand whenever we withdraw, depending on the amount, the government will take a portion of that for themselves. How lovely!
It’s time to take a look on what’s reflected on the personal income tax return.
When I was looking into this, I was trying to understand if the full amount of the withdrawal would be added, or netted against the withholding tax amount.
To me, it seems that it’s the full withdrawal amount that is added to your earned income, which I will try to display momentarily.
Therefore, you technically have to pay additional tax on the withholding amount. So, the 10% that is withheld will also technically be taxed at your provincial and federal personal income tax rate.
Yet, I must state that I’m not a tax advisor, and this wasn’t entirely made clear through some of my research.
Nonetheless, let’s look at an example.
Serge had a roller coaster of a year. He worked as a janitor at his local school until the middle of the year, where he decided it was finally time to set up his own masterclass in stonks.
He decided to quit and use the money he has been saving up from his RRSP to help fund the costs.
During the year, he earned $30,000 from working at his local school, while withdrawing $6,000 from his RRSP. Serge decided to publish a book about stonks that was taken on by a local publisher and was paid some royalties through the sales. The total amount earned was $1,500.
However, as he set up his masterclass, very few people decided to purchase his services, and he spent much money through his savings to market it everywhere. Serge was left with a $25,000 net loss at year end.
As we can see in the picture above, the withdrawals are simply added to the net income as earned income, then taxed at the provincial and federal rate. Note this is just a rough example and not an actual implication of how tax returns are done at year end.
Before any tax credits, Serge would owe $3,050 to the appropriate authority. Below you will also see the amount of withholding tax charged on the date of withdrawal. 20% is no meager amount!
How RRSP works after retirement:
Here when you reach the age of 71, or you’ve retired and are going to rely on the income generated from your RRSP, this is where you will slowly begin to draw from the account itself.
Now, as we have seen above, you should have a basic understanding of how you’re going to be taxed on these withdrawals over the years.
But if you do not need to withdraw from your RRSP all from once, then it probably is a good idea that you don’t.
Consider this: if you never had a couple million dollars in the account and wanted to withdraw all that your turn 60 or 65, do you really want to pay nearly 50% of that tax?
Probably not. So, the easier decision would be to slowly withdraw it over the years while paying a minimal amount of taxes you can.
Different options where you can set up an annuity or an account to avoid paying tax and keep the funds there were needed or pay less tax.
Types of RRSP investments:
So, when you’re looking to open an RRSP, what are the different investment options?
Well, you could always just open an RRSP with the bank that offers an interest rate and deposit your money over the years to generate some income. The only fault to hat is that you’re likely not to get an interest rate of 2%. If you are, great. If you can get anything more than 2% again, that’s great. However, that’s barely going to cover inflation which in a way is a very sneaky tax.
So, of course, if you want to have a self-directed RRSP and start investing in the stock market, that is always an option for you. You can hold various stocks, bonds, ETFs, or other public securities into your RRSP.
Now you can always have a portfolio manager that invests on your behalf or hold mutual funds or ETFs to be a passive investor and earn returns very similar to the stock market as a whole.
The options are seemingly endless, although not entirely. However, it’s nice to have various options for you to choose for your investment style and, of course, your needs.
What is the RRSP contribution limit?
Now there is a limit that you can contribute to your RRSP within a given year.
But it’s much different from the TFSA contribution limit that is prescribed each year. There’s no actual limit set by the government.
The annual contribution limit is based on two factors:
1. 18% of your earned income
The maximum amount that you’re able to contribute to your account is the lesser of these two.
What qualifies exactly as earned income?
Typically, earned income is classified as employment income, self-employment income, royalties, and other incomes.
Here’s a list of some the income sources that the Canadian government considers as earned income:
- Employment income
- Self-employment income or loss
- Net rental income or loss
- Support payments received or made
- Research grants
- Unemployment benefit plan payments
- Canada and Quebec pension plan disability benefits.
Can RRSP contributions be carried forward?
RRSP contributions can, in fact, be carried forward.
In a given year, if you do not use any or a part of your contributions, that can be carried forward as unused contribution room.
How long can it be carried over for?
The greatest thing about this question is the answer, and that is there is no limit in which you cannot carry forward any unused contribution room.
The only instance that I could think of is if you turn 71 and want to open the RRSP, I don’t believe it’s possible to do so because of the requirements at 71.
How to calculate your total RRSP contributions:
If now you’re wondering how much contribution room you have for your RRSP or can have, we’re going to break it down.
So, to calculate the total contribution room that you are entitled to, we must look at the current year’s contribution room and previous contribution rooms.
It’s probably going to be a little bit difficult if you don’t know your previous year or year’s contribution room. I understand not everyone has their total income calculated and on hand.
However, if you have a CRA account, you can check the total contribution room that you have. I would recommend logging in looking for the page that gives you this information.
But you just take your current year’s contribution room and the contribution room unused in any previous years and add them together.
If you know me by now, you understand that I like to give examples, so let’s look at an example of how this all works.
In this example, I’ve based it as someone who hasn’t contributed to their RRSP ever before. This gives you and I the chance to look at how they accumulate their contribution room over time and how it’s carried forward.
A breakdown of the earned income this individual has earned over the four years is highlighted below.
Then the calculation of each year’s contribution room available.
Finally, we are able to see how the contribution rooms from the previous three years are added and carried forward. There’s no magic involved here. It’s just adding the previous year’s amounts that have been untouched.
Yet, you’ll notice that we use the annual limit amout of $27,830, rather than the 18% of earned income. Once again, as a reminder, the RRSP calculation room is solely calculated as the lessor of these two amounts.
Hence why in the calculations above you only notice the calculation of the percentage of earned income, because the individual has not earned nearly enough income for us to consider which of the two amounts would be used for their contribution room.
Can you contribute to an RRSP if you have no income?
I think the answer here is no. RRSP is not similar to a TFSA.
But it depends maybe on your definition of income. If you are self-employed and your business is obviously generating your income, that contributes to earned income.
I would encourage those who don’t think they can contribute to an RRSP because they do not work to check the list of earned income on the government of Canada’s website.
However, with a TFSA it’s not the same when you have no income at all. You can still contribute to it because of the annual limits the government prescribes.
But if your earned income is zero for the current year, then your existing contribution room will obviously be zero.
We can still count between RRSP with an unused contribution in this situation. If you have worked in the past or have generated earned income in the past years but have not contributed to an RRSP or partially have, you can still contribute the remaining amount in the current year.
An RRSP, who can contribute?
There’s only really a couple of people that can contribute to your RRSP account. The first one is obviously yourself. The second one being your common-law partner or spouse, depending on if you registered for a spousal account.
But any other family member like a parent or aunt’s uncle cannot contribute to your RRSP to my awareness.
Over contributing to an RRSP:
If you over contribute to your RRSP, it may not be at the end of the world.
There is usually a $2,000 cushion, so if you contribute less than $2,000 to RRSP, then your deduction limit will not be taxed on it.
The cushion there is nice to take advantage of when you need to. But if you over contribute by more than $2,000, there are some taxes and penalties associated.
It’s very similar to the over-contribution plans that a TFSA has. You were taxed 1% per month on the over contributed amount.
So that means if you over contributed to your RRSP for 3 months, you’re taxed 1% on each of those 3 months.
However, if you over contribute and withdraw within relatively the same time, you will not be taxed as a result.
Obviously, accounts like these are not meant to be taken full advantage of. You cannot just abuse your power to get as much of a deduction as you want.
You need to play to their game, not all Free Willy.
There may be some ways where you can have the tax lifted. If there was a legitimate reason for your overcontribution, the Canada Revenue Agency might be willing to strike the penalty.
Or, if you’re taking the necessary results to eliminate the overcontributions, that may be a reasonable action for them to cancel the tax on excess amounts.
Last day to contribute to RRSP 2021:
Every year there is a last date for you to contribute to your RRSP.
Now it should be said that after the state, you can still contribute to your RRSP. What this entire date signal is the last date your contributions will be deductible for tax purposes.
So, the last day to contribute to your RRSP during 2021 was March 1st. If you have contributed to your RRSP after this date, any amounts will be deductible on next year’s tax returns.
If you remember from the discussion above, there are two periods you need to have in mind when contributing to your RRSP.
While maybe through some sort of media, you will hear that there is a deadline for RRSP contributions, just know that the deadline is for you to deduct any contributions on your current tax returns.
This does not mean you can no longer contribute to your RRSP.
When do you need to start withdrawing?
You can start withdrawing from your RRSP basically whenever you want. There really aren’t any restrictions that require you to hold a certain amount or hold your contributions into the account for a particular period.
However, you may decide to hold all your contributions until the foreseeable future. Yet, the Canadian government requires you to start withdrawing from your RRSP whenever you return from age 71.
The requirement to start withdrawing is not on the exact date of your birthday. Instead, it is on December 31st of the year in which you do turn 71.
When that day comes, what are you supposed to do? Well, of course, you can make withdrawals and start earning some of the money that you have gained throughout your RRSP.
Well, this will likely cause you to pick a considerable amount in taxes; there are a few different methods you can choose instead of withdrawals.
You may decide that you want to purchase an annuity. Now, if you’re not familiar with what an annuity is, it’s basically just another type of investment that you can buy, and over time, it will pay you money.
Now this money is usually in the form of the return of your own capital, so the amounts you contribute. As well, you will receive some interest based on the term of the annuity.
The whole concept behind it is that the longer you hold your annuity, the longer the payments, the more interest you can receive.
As well you can select how often you want to receive your payments. This is an excellent option for you whenever you start getting older and need to rely on this income as a primary source. Bills don’t necessarily get cheaper when you reach that age, although it would be nice if they did.
There are a couple different annuities you can choose from.
A life or term certain annuity basically pays you regular amounts based on your selected term or until you die. This, of course, means that you could earn more than what you have invested initially, but of course, this could mean the opposite.
A variable annuity is where you provide the contribution to a portfolio manager or some sort of investment advisor. They will go ahead and invest contributions in some kind of equities. In turn, you will receive your regular payments as well as the variable payment. The varying amount does depend on the performance of the investment.
You may also not receive as high of a regular payment as you would have with the other two options listed before.
The other option available to you is setting up an RRIF, known as a registered retirement income fund. Whenever you have turned 71, you can transfer your RRSP to this type of fund, ultimately tax for you.
However, every year there is a minimum amount that the Canadian government requires you to withdraw.
Now the minimum amount that you need to withdraw seems to be based on your age. It’s very likely that your financial institution or insurance company, whoever maintains the fund, will calculate this minimum amount. So, if you have an RRIF and don’t know the minimum amount you need to withdraw, it’s best to speak to one of your financial advisors to learn more.
However, this allows you to slowly withdraw some of the amounts you have earned over the years instead of having to withdraw them all at once.
Can you use RRSP to purchase a house/car/etc.?
There’s something that’s called the home buyers plan. The concept around this is it allows you to withdraw from your RRSP specific amounts that are tax-free and use it to purchase or build a home of your own or for a related person with a disability. Overall, it lessens the amount of mortgage you may need.
The maximum amount you can withdraw with no withholding tax is $35,000. As well there are a few requirements. You cannot currently own a home to be eligible under this plan. You need to be a first-time homebuyer, as well you need to be a resident of Canada to be able to take part in the plan.
Yet, it’s under this plan that you have to make payments back. You have a total of 15 years to pay back the total withdrawals you have created from your RRSP or another related account.
I believe that you can contribute to your RRSP that will act as a deduction and, therefore, count as a part of your repayment. However, any amount said is solely for repayments and non-contribution you are not eligible to deduct.
This is all because you have originally deducted the withdrawn amount at some point earlier in time.
Unfortunately, I’m not too informed of the home buyers plan to give a very informed article or detailing. And said I would encourage you to check the government of Canada’s website for more information if you’re interested in this or want to learn more.
If you are looking to purchase a vehicle or some other expensive products, I believe you will have to withdraw the amounts from your RRSP and use that money; however, you still will be taxed on those withdrawals.
A lifelong learning plan allows you to withdraw up to $10,000 per year for funding if you or your spouse or common-law partner are going to attend training or education.
RRSP employer matching:
Whenever you were getting hired at your current workplace or maybe a previous workplace, when asking about the benefits you can receive as an employee, you may have seen that your employer makes RRSP matching contributions.
This means that in some cases, any amount that you contribute to your RRSP will be matched by your employer. Now, this does not necessarily mean that if you contribute $20,000 that they will contribute another $20,000. There may be some limits as to the amount they will contribute.
In some cases, as well, they may base the amounts they’re willing to contribute to your RRSP as a percentage of your salary.
For example, if you are going to earn $45,000 yearly, your employer may give you the option to select a contribution amount of between 2 to 4% based on your income. Therefore, they would be willing to contribute $900 – $1800.
So if you are a part of a group RRSP that basically allows both you and your employer to contribute to this RRSP, any amount you contribute is tax-deductible as well as any amounts they contribute. However, contributions made by your employer are included in your earned and taxable income.
So, from my understanding, this is how it would look:
Therefore, the contributions the employer has made is counted against the total room that is available for the individual. As well, here, I calculated the contribution from the employer as 4% of the $45,000 salary paid out.
Transferring RRSP to TFSA:
I don’t believe you can do an automatic switch or transfer from an RRSP to a TFSA. If I’m wrong, please let me know down below.
If you had an RRSP and decided one day that instead, you wanted to open up a TFSA, you would need to withdraw your funds from your RRSP and then contributed to the TFSA.
As you probably are now thinking, you would be taxed on those withdrawals from your RRSP.
That’s probably why it is more ideal that when you’re starting out investing, you decide which investment account will be the best for you.
Of course, it’s hard to argue with that tax free savings account. But this only makes sense as your RRSP is your pre-tax dollars, and your TFSA is after-tax dollars. So necessarily wouldn’t make much sense to contribute your pre-tax dollars into a TFSA and not having to pay tax on it.
Can RRSP be transferred to spouse:
No, it does not seem like you can transfer your RRSP or amounts of your RRSP to your spouse. To transfer amounts in your RRSP, the Canadian government requires you to be the same owner of another RRSP.
So, you can transfer your RSP from bank to bank, but this does not allow you to transfer it’s to your common-law partner or, of course, your spouse.
Transferring RRSP from one bank to another:
As mentioned above, you can transfer your RRSP or other investment accounts from Bank to Bank or, of course, bank or brokerage.
I will look at the steps that, Wealthsimple requires you to do to transfer an RRSP to their brokerage.
If you want to use a different brokerage or financial institution, such as the RBC Royal Bank, CIBC, or TD, just look up their policies. I hope you ensure they have some Canadian investor protection or some sort of investor protection fund as losing money from a non-verified and protected broker is a huge loss.
Anyways, the first thing you need to do is download a statement from the investment account you want to transfer.
This is just to display the amount that you are going to transfer and some of your other details. So, of course, this means that you should make sure that all of your details are up to date and current.
There are a couple different ways in which you can choose how you want to transfer the amounts. The first is by cash, so your current financial institution or brokerage would dispose of all the holdings in your account and then send everything over as cash.
If you’re looking at this option and would clearly rather have your investments transferred over entirely, you can also choose another option. However, what will happen is they still will need to liquidate all of the investments in your current portfolio. Still, Wealthsimple within goes ahead and reinvest the funds directly back into the holdings and equities you had. It just may take a little while to do so.
Or, of course, you can just have a part of the cash that you have in your current investment account over to Wealthsimple.
Of course, you will want to go to Wealthsimple or your brokerage’s website or mobile app and request a transfer to get the process started. You’ll need some good basic details like the account number associated with your current investment account.
So as always, make sure your information is up to date. If you want to start investing in your new investment account soon, it’s best not to hold this off for too long, and it doesn’t hurt to look at the transfer fees your current brokerage or institution may have to transfer the investment account.
Is a 401k like an RRSP?
The simple answer here is yes. If you’re not familiar with what a 401k is, it is a US investment account that people can open up with their employer.
The employee can deduct specific amounts from their paycheck to contribute to their 401k. Then the employer has the option to match part or all of that contribution into the investment account.
Employees can use this as a tax advantage as they can deduct contributions from their tax returns.
There are certainly similarities between the two investment accounts, and I would likely compare it to the American version of the RRSP.
Sure, they do differ in some ways, but overall, it is very similar in nature.
RRSP US Dividends:
You may have heard that with the TFSA, there is a 15% withholding tax on any us dividends earned. This means that if you hold any stocks of American companies that pay dividends annually, there’s a 15% withholding tax on those dividends.
It is a slight disadvantage to owning a TFSA. With an RRSP, there is no such withholding tax. Meaning that if you earned dividends from US stocks or other equities, you could fully keep the dividend without paying any tax on it.
Now as we have come to know, of course, there is a withholding tax on withdrawals from RRSPs, so at least you don’t pay an additional withholding tax.
Why an RRSP is good to have:
So there obviously are some benefits of an RRSP. If you’re reading through this so far and seeing that the tax you have to pay is why you don’t want to invest in the RRSP, just understand that the most significant benefit that this account provides is the current tax adoptions you will be able to use.
So likely now, then later, you’re going to be in a higher tax bracket. Maybe you are employed and have some investments in real estate or own a couple businesses, I’m not sure. But you likely pay a fair amount in taxes each year.
The RRSP is designed for you to pay less while you’re able to grow your money for retirement or other goals so you may have.
Being able to use a group RRSP and have your employer contribute to it is basically like free money. While the amount may not be huge, it’s still an amount nonetheless. Of course, this amount is added to your taxable income, but at the same time, it’s also deducted.
So ideally, an RRSP is a tremendous long-term investment account because you probably won’t have a lot of income coming in later on in your life. At least you won’t be employed or maybe home a business still. Ideally, you may be sitting on the beaches in Miami, sipping on a pina colada.
Why the RRSP is a bad idea:
But as much as I would love to sit here and tell you how great the RRSP is, even I have to admit that the taxes you will be paying later isn’t very ideal.
Not only are you subject to pay personal taxes on your withdrawal amount, but there’s also a withholding tax you must pay. So, if you want to withdraw large amounts from your RRSP, well, you’re going to be forced to pay the consequences.
If later in life you think that you’re going to have a lot of money coming in from your investments to the point where you will be able to travel the world and accomplish everything you want to at that stage of life, you may question whether an RRSP is worth it?
Well, considering that you’ll have to pay more tax and might even be bumped up to a higher tax bracket in these situations, it may not be worth it.
Was the fact that your employer contributions to group RRSPs are added to your taxable income that could boost you in an ultimately higher tax bracket in the current term rather than later.
If you are relatively young, maybe you’re in your 20s and 30s. How much contribution room do you exactly have? Likely when you’re in your teens, you may not have been working at a job that much, or if you are, you may not have made substantial amounts of annual income.
The amount of contribution room you may have annually could be less than the annual limits for a TFSA.
Likely the total contribution room you would have for a TFSA is more significant than that you will have for an RRSP.
RRSP is really designed for those starting to get themselves into the workforce and earn more of a salary to contribute the annual limit to their accounts.
If you’re relatively young, you could be missing out on that large amount of contribution room of a TFSA if you opt for an RRSP.
Overall is an RRSP worth it?
I mean to have the tax deductions available for you now obviously is worth it. But for the taxes, you will eventually pay and maybe the low contribution room you will have now over compared to a TFSA it may not be.
I still think an RRSP is an excellent investment account, and the fact that when you turn 71, you have a couple different options to hopefully pay fewer taxes on your withdrawals makes it better.
But there’s obviously something about having tax-free savings account for retirement or when we get older that is just too lucrative to pass upon.
If your employer is willing to contribute to your RRSP or even match amounts, I think it is worth having an RRSP. Even if it’s just slightly contributed into it year after year to get the matched amount from your employer or any contribution from them.
It’s free money, basically, and who doesn’t like free money?
But in all seriousness having an RRSP is a great way to pay fewer taxes currently as long as you don’t mind paying taxes later in life. Of course, an RRSP is relatively simple to set up, and even if you don’t want to invest in it directly, there are many options for you to have someone else do it or just earn a stated interest annually.
So don’t turn your cheek away from this investment account just because of the potentially significant tax you may eventually have to pay and how solid of a retirement savings plan it can present.
Thank you for reading this article today. Don’t forget to sign up for the newsletter and receive your free budget spreadsheet to assist you in your financial planning and even retirement planning. Check out my other article on your complete guide of a TFSA to learn more about the differences between an RRSP and TFSA.