What is an RRSP

What are RRSPs anyways?

RRSPs are great for many reasons. But what the hell are they?

A conversation I had awhile back with a friend:

Friend: “Should I invest in RRSPS?”

Me: (Throwing arms in the air) “RRSPS ARE NOT INVESTMENTS!”

Friend: “Oh, uhh what are they?”

RRSP stands for Registered Retirement Savings Plan. Introduced in 1957 they were made available encouraging Canadians to save for their retirement. The account itself is not an investment, but you can (and should) stash assets within them.

Think of yourself rockin a super awesome fanny pack. I wore one as a millennial kid because statements had to be made and I’m cool like that. I could hold all sorts of awesome shit in it. Now let’s pretend your fanny pack is the RRSP, and the awesome shit is actually assets like guaranteed investment certificates (GICs), stocks, bonds, mortgage loans, mutual funds, exchange traded funds (ETFs) and the list of investments you may hold goes on. Holding things in your fanny pack for 30 or 40 years doesn’t sound sexy, I know. But leaving them in there to increase in value will make it all worth while.

Bruce Sellery says it better with his wine cellar analogy, but for whatever reason I chose a fanny pack. This is my blog and I can do what I want. Just go with it alright?

Hold the tax please

When you contribute to an RRSP, you will be paying the government less in taxes.

Say whaaaat?

You’ll be like an anarchist not paying taxes on a certain amount each year. Hell no, I won’t pay! (Yeah you will, but when your older and have less energy to complain about minuscule things; like the government issuing taxes on your hard-earned money. Boo hoo, get over it. You live in a great country.)

Contributing to RRSPs allows you to deduct from taxable income. What that means is that your contribution will taken from your pay cheque before income taxes are deducted. When your socking away after taxed dollars into your RRSPs, you will get a tax refund when you claim that amount at the end of the year. Revenue Canada will allow you to subtract your contribution amount from your top-level of income.

If you’re in a higher tax bracket, RRSPs are a great way to defer taxes.

As well as lowering your taxable income, any income earned in your account is not taxed. Interest, dividends, capital gains or whatever other monetary gains are going on in your awesome fanny pack of wealth creation go on tax-free.

The government is giving you a pass for now, but it is important to note that eventually they will want their share. This will occur when you start withdrawing from your RRSPs or RRIFs. The amounts withdrawn will then be taxed as income. You will probably be in a lower tax bracket when that happens, so you’ll pay less income tax by then. It really goes to show how beneficial RRSPs are in regards to taxes.

Play by the rules

There are certain rules that stipulate how much you may contribute. Every year Canada Revenue Agency will send you a Notice of Assessment that will tell you your contribution limit. It will be 18% of your previous year’s earnings (to a maximum set out by the CRA; the amount grows every year. See CRAs website for RRSP Limits.).

Contributing more?

Well any amount $2000 over the deduction limit is going to have a tax penalty (1% per month according to CRA).

Getting old?

You must cash in on your savings by the end of the year you turn 71. The government wants to share your savings eventually. You will have to withdraw or transfer to what’s called a Registered Retirement Income Fund (RRIF) or annuity. Investments within the RRIF may continue to grow tax-free, however a minimum RRIF withdrawal is made each year and sent out to the account holder.

Can I contribute?

“I don’t know CAN YOU?” (Did anyone ever get that when you’d ask to go to the washroom in school? Oh teachers you are so funny *rolls eyes*)

YOU MAY! Pretty much any working Canadian may contribute. As long as you are:

  • Less that 69 years young
  • Have contribution room in your fanny pack
  • Do your taxes with the Canadian Government like all the other good boys and girls do

So when I started my first taxable income job at the ripe age of 14, I was allowed to contribute. If I could kick high enough to reach my face, I would probably do it so hard I’d knock myself out for not doing this. Hell I’d kick myself so hard for not having any sort of savings.

What if I want to withdraw before I retire?

Bad! It is your money, and you are aloud to withdraw it at any age. But premature withdrawals will come with a wooden spoon across your ass (there are certain conditions that allow you to withdrawal from RRSPs without the wooden spoon, I’ll get to that in a second).

With early RRSP withdrawals, you’ll be punished with higher taxes and reduction of your contribution room. When you take from your RRSPs early, the financial institution must deduct whats called withholding tax. The withheld tax will reduce the overall taxes owing at the year’s end. How much is withheld? Well in most of the provinces (with the exception of Quebec):

  • Up to $5000 = 10%
  • $5001 – $15000 = 20%
  •  Anything greater than $15000 = 30%

Another kick in the butt is that you will lose contribution room. You wouldn’t be able to recontribute the funds you have withdrawn unless you had additionally room available.

There are a couple of exceptions when pulling out early (no sexual innuendo intended). These are the Home Buyer’s Plan (HBC) and the Lifelong Learning Plan (LLP). I think I’ll dive into these as their own posts at a later date but for now just to briefly illustrate:

  • The Home Buyer’s Plan. You are allowed to withdraw funds from your RRSP in order to purchase your first home under the HBP. Individuals may borrow up to $25000 tax-free from their RRSP as long as the full amount is paid on time in full. With a spousal RRSP you may combine another $25000 towards your home. You will be given a 2 year grace period, there after your timer sets in and you have 15 years to repay this amount without being penalized.
  • The Life-Long Learning Plan.  Under this plan, you are allowed to again borrow from an RRSP. If you want to further your education the government allows you to withdraw up to $10000 per year to a maximum of $20000. You’ll have 10 years to repay this amount without penalty. Repayment must commence no later than the fifth year after your first withdrawal.

Are there different types of RRSPs?

That’s a great question, I’m glad you asked!

Yes.

  • Individual RRSP. Pretty self-explanatory title. You are the individual, and it is your RRSP. You are in charge.
  • Spousal RRSP. Also pretty self-explanatory title. You and your spouse share the RRSP. Your wife is in charge. Kidding! (But really am I?) There’s a lot that can be said about spousal RRSPs, but we can talk about that later. For now it’s important to note that when splitting income in retirement, the marginal tax rate will be lower than if one person earned all of the income. Tax savings are a great perk for sharing with your loved one.
  • Group RRSP. The employer sets up a group RRSP and takes a deduction off of the employees payroll; however much they decide to contribute. The money is still invested into an individual account for yourself, but your employer takes pre-taxed dollars right off your pay cheque and it is invested within products of your choosing that your company has available. I currently have a pretty decent plan set up that works a little differently. Instead of choosing an amount off of my payroll, my benefits pay me $3 an hour towards my group RRSP plan. No money is withdrawn from my pay cheque for this. A lot can be said about group RRSPs. I’ll just mention that it’s important you check with the HR at your place of employment to see what the company offers. Oh and a really important to side note: Check if your company matches contributions. If they do, get that shit set up yesterday. It’s free money.

What if I croak?

Morbid thought, isn’t it? But seriously, don’t forget that we are not invincible. Again, this is another one of those things that is another post itself. We won’t dive into too much detail here.

Just note that the government doesn’t mind dipping their hands into a dead man’s wallet. Oooooh this is getting morbid. Generally the value of an RRSP or RRIF will be taxed on top of the income during the year the account holder passed on. The terminal tax return is the last filed return under the deceased name, and the RRSP or RRIF will be included as income on it.

There is an exception to this. If you have a spouse, your RRSPs assets would be passed on to the widow, tax-free. This is provided that you fill them out as your beneficiary. They would receive your estate and their contribution room would remain unaffected.

Black widow spiders are pretty freaking scary. I’ve heard that the females eat their mates after copulation. I don’t know why they do, but if there were spider RRSPs I would argue that’d be an ultimatum…

Let’s recap, shall we?

We’ve covered a lot here. There is a lot more that can be said, but it’s already a pretty beefy article that brushes the surface of RRSPs. Let’s end it here, and do a quick recap of what we have learned.

  • RRSPs are not investments. An RRSP is simply an account that you can hold savings and investments within.
  • Lower your income tax. A huge benefit of RRSPs is with regards to taxes. Contributions allow you to deduct from your taxable income, thus putting you in a position to pay less income tax during your working years.
  • Tax deferred growth. Another tax benefit is the accumulation within the account that is tax-free. Any monetary gains going on do so without the account holder having to pay taxes on the interest.
  • You are allowed to contribute 18% of your previous years earnings. To a maximum set by CRA. You will be penalized substantially on anything $2000 over the limit.
  • You must withdraw by the age of 71 You may withdraw the full amount (not recommended) or convert it to an RRIF or other annuity. This must be done within the calendar year you turn 71.
  • Any working Canadian under the age of 69 that pays taxes may contribute. Even adolescents.
  • Early withdrawals are baaad bad bad. With the exception of the Home Buyers Plan (HBP) and the Lifelong Learning Plan (LLP) you will be punished for early RRSP withdrawals; paying income tax and losing valuable contribution room.
  • There are different plans. Individual, spousal and group RRSPs are different types of plans.
  • Take full advantage of company matched contributions. Head on over to your HR department at work and see if this is an option. If available, get it set up yesterday.
  • If you die you will still owe the government money. With the exception of a spouse that can receive your estate tax-free as your beneficiary, the amount in your RRSPs will be added as income on your terminal tax return.

That does it for this one. I hope from reading you have a better understanding of RRSPs and what they are; Ridiculously Rad Savings Plans.

 

Later days,

-Jason

 

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