A Beginner’s Guide to RRSPs

(File photo: Max Harlynking/Unsplash)

A registered retirement savings plan (RRSP) serves as a cornerstone of retirement planning for Canadians. Introduced by the government in 1957, this retirement vehicle is meant to encourage individuals to contribute by exempting tax from contributions and income earned so long as the funds remain in the plan.

Benefits of RRSPs

RRSPs are popular because of the benefits they provide people saving for retirement. Aside from contributions being tax-deductible, the savings grow tax-free as well (so long as they stay in the plan). This compounding allows your savings to grow at a faster rate.

Moreover, your RRSP can help you fund your first home or even your education. You can take out up to $25,000 for a down payment under the Home Buyer’s Plan, and up to $20,000 for education costs under the Lifelong Learning Plan. These withdrawals are also tax-free so long as you pay the money back within a specified time period.

Setting up your RRSP

Before going about setting up an RRSP, it’s important to understand the different types and how they work. This includes individual, spousal, and group — all of which have their own pros and cons. Then, talk to different banks and ask about their investment options and what the fees are. You’ll also need at least two (2) copies of personal identification when you open an RRSP.

When should you contribute to your RRSP?

If your employer offers a matching program, take advantage of this. Some companies may choose to match their employees’ RRSP contributions, which can often add anywhere between 25 cents and $1.50 for every dollar put into the plan. This is essentially a “free” gift from your employer, which can guarantee 25-150% returns on your contribution.

If you’re also experiencing a spike in your income, and suspect that it won’t be as high in retirement, then let your money grow in an RRSP tax-free. By the time you withdraw the funds during your retirement, you’ll hopefully be taxed at a lower rate. This is why contributing to your RRSP makes more sense during your high-income working years, rather than when you’re just starting out in an entry-level position.

A good rule of thumb when deciding when to contribute is to consider what is going to benefit you the most from a tax perspective.

Be wary of withdrawing early

Unless it’s for a dire emergency, withdrawing your RRSP early is generally a bad idea. This is because you’ll have to report the amount you take out as income on your tax return, and you won’t get back the contribution room you originally used.

To make matters worse, your bank will withhold tax from your withdrawal — 10% on withdrawals under $5,000, 20% on withdrawals between $5,000 and $15,000, and 30% on withdrawals greater than $15,000 — and pay it directly to the government on your behalf. This means that if you take out $20,000 from your RRSP, you’ll not only end up with just $14,000 but you’ll also have to add $20,000 to your income come tax time.

What kind of investments can you hold inside an RRSP?

Investments that can be held in an RRSP are called qualified investments. This includes cash, gold or silver bars, savings bonds, treasury bills, bonds, RRSP-eligible mutual funds, ETFs, equities, Canadian mortgages, and more. If you own any of these qualifying investments, it’s possible to transfer these to an RRSP and obtain a deduction based on their market value. On the other hand, some investments you can’t hold in an RRSP include other precious metals, personal property such as art, antiques, or gems, and commodity futures contracts.