The Registered Retirement Savings Plan (RRSP) is a popular retirement savings tool in Quebec and across Canada. It allows residents to set aside money for their retirement while benefiting from tax advantages. Would you like to understand how an RRSP works and what its benefits are? EB Tax Advice explains what you need to know on the subject!
What is an RRSP?
The RRSP is an account registered with the Canadian government that allows individuals to contribute money for their retirement. The contributions are tax-deductible, meaning you can reduce your taxable income by contributing to an RRSP.
This savings plan offers numerous tax benefits to taxpayers:
- Tax deduction: amounts contributed to an RRSP are tax-deductible from your taxable income. For example, if you earn $50,000 and contribute $5,000 to your RRSP, you will be taxed on $45,000.
- Tax-sheltered growth: earnings in an RRSP (interest, dividends, capital gains) are not taxed as long as they remain in the account.
- Taxation upon RRSP withdrawal: when you withdraw money from an RRSP, the amount withdrawn is considered income and is taxed at the applicable marginal tax rate.
How does an RRSP work in practice?
To start contributing, you must open an RRSP account with a financial institution like a bank, credit union, or brokerage. Once the account is opened, you can make annual contributions, up to 18% of your previous year’s earned income, up to a maximum set by the Canada Revenue Agency (CRA), which was $30,780 for 2023.
These contributions are then deductible from your taxable income, which immediately reduces your taxes for the current year. Funds in the RRSP can then be invested in various financial products such as:
- Stocks
- Bonds
- Mutual funds
- Guaranteed Investment Certificates (GICs)
- Exchange-Traded Funds (ETFs)
The growth of investments is tax-sheltered until you begin withdrawing funds. Withdrawals, which are taxable as income, are generally made during retirement when your income is typically lower, allowing you to pay less tax on the withdrawn amounts.
What is the maximum RRSP contribution?
The maximum RRSP contribution is calculated annually. Each year, when you file your tax return, a contribution room is assigned based on your situation. It is calculated as follows:
- 18% of your earned income from the previous year,
- Or a fixed amount (for 2024, this amount is $31,560).
However, if you do not use your full contribution room in a given year, you can carry forward this room to future years.
What is the RRSP contribution deadline?
To deduct contributions from the current year’s taxable income, they must be made by the deadline. This deadline is usually 60 days after the end of the calendar year, typically in early March. The RRSP deadline for 2024 is March 1, 2025.
How to withdraw from an RRSP?
To withdraw funds from an RRSP, you must contact your financial institution and complete a withdrawal form. The institution will withhold tax, generally between 10% and 30%, depending on the amount withdrawn.
The withdrawal is then added to your taxable income for the current year. At the end of the year, you will receive a T4RSP slip indicating the amounts withdrawn and the tax withheld, which you must include in your tax return. Funds can be withdrawn via transfer or check, depending on your preference.
How does an RRSP work: Specific use cases
RRSP splitting between spouses
A spousal RRSP allows a taxpayer to contribute to their spouse’s RRSP. This can be beneficial for tax purposes if the spouse is in a lower tax bracket. This way, you can split the income between spouses and reduce the total tax payable at retirement.
Locked-in RRSP
A locked-in RRSP (also known as a Locked-In Retirement Account or LIRA) is a special type of RRSP where the funds typically come from an employer pension plan. The funds are locked in, meaning they can only be withdrawn under certain conditions, usually related to retirement.
Tax on early RRSP withdrawal
Early RRSP withdrawals are taxable and subject to withholding tax. However, there are exceptions, such as under the Home Buyers’ Plan (HBP RRSP) and the Lifelong Learning Plan (LLP).
RRSP inheritance upon death
In case of death, the RRSP balance is generally included in the deceased’s income for the year of death, unless it is transferred to a surviving spouse or dependent child (under certain conditions), in which case the tax may be deferred.
Plan your savings strategy with professionals
Now you know the basics of how an RRSP works! In summary, it is a powerful tool for saving for retirement while benefiting from immediate tax advantages. However, it is crucial to understand the rules to make the most of it.
Managing your RRSP is part of an overall financial planning strategy. It is advisable to consult a tax expert to maximize the benefits and ensure that your contribution and withdrawal strategies align with your retirement goals.
