The Registered Retirement Savings Plan (RRSP) in Canada is a savings scheme established for the main purpose of retirement. Every country has a retirement age. In most countries, retirement begins at 65.
This figure (65 years) is arrived at based on the physiological development of humans. It is expected that you don’t have the same virility and energy to work long hours while maintaining the quality of life and good health.
Once you hit that age, it is expected that you stop working actively and your income will naturally nosedive.
RRSP is a scheme introduced by the Canadian government to ensure that the average Canadian is prepared for the inevitability of old-age by setting aside a portion of their earnings throughout their active years.
In some countries, a portion of your earnings is automatically deducted each time you receive a paycheck which literally forces you to save some money for your future self.
History of the RRSP
The plan has existed since 1957 and has been helping retire happily ever since. The main benefit of RRSPs is that you get to defer all taxes until retirement.
How does RRSP Work?
In technical terms, RRSPs are tagged Tax-advantaged accounts. These are accounts that the government allows you to legally pay lesser or no tax at all to encourage more savings.
All the funds in your RRSP are tax-free as long as you don’t attempt to make any withdrawals.
Who is Eligible for RRSP?
Opening an RRSP is very easy. All you have to do is walk into your local bank or financial institution to fill out the forms. The eligibility conditions are quite basic.
- Be under the age of 71
- Be a Canadian resident for Tax purposes. i.e. Earn your income and file your tax returns in Canada. This means that if you are an immigrant that lives & works in Canada, you are eligible for RRSP provide you file your tax returns with the Canadian Revenue Agency (CRA).
- Minors Under the age of 18 can also open an RRSP with the written consent of their parents or legal guardian
How much does the Average Canadian Have in their RRSP?
To work out this figure, we have to know the number of workers in Canada and calculate their expected RRSP balances based on the average income of the Canadian economy.
- Average Annual Salary in Canada: In 2020, the average Canadian salary was about $65,000 CAD.
- RRSP Deduction Rate: The RRSP deduction benchmark is 18%
- The Age of the Average Canadian: 41 years old according to World Bank
- Average Working Duration: If we assume that the average Canadian starts working full time at Age 25. Then it means that on average, most people have been working and saving in their RRSP for the 16 years
Average income x 18% RRSP x Median Working Age duration (25-41 = 16)
= ($65,000 x 18%) x 16 years
= $187,000 CAD
This computation is evident in the Bank of Montreal (BMO) annual RRSP study. The reports that as of Q2, 2020 over 69% of Canadians held at least $111,922 ($142,251 CAD) in their RRSP. The effects of the pandemic uncertainty have since driven up this figure.
Today more Canadians are investing in their RRSPs more than ever.
| Region | Average Amount Held in RRSP |
| Ontario | $128,742 |
| Alberta | $116,426 |
| Quebec | $99,659 |
| Atlantic | $96,530 |
| Prairies | $92,127 |
| British Columbia | $96665 |
What happens to the money you have in your RRSP?
The money is kept with a financial institution, they invest this money into diversified low-risk portfolios, to ensure that you are paid a healthy percentage on your savings. This helps to prevent your funds from being eroded over time by inflation.
By how much will Your RRSP Grow Annually?
The average returns on retirement savings accounts in Canada tend to hover around 4% to 8% yearly. This figure, though quite conservative, is sufficient to overhaul the effect of annual inflation. It sure adds when you compound it over the years.
What are the Benefits of an RRSP?
Asides from the fact that you get to claim your RRSP contribution as a deduction on your tax return. You also get to enjoy some other benefits.
- Passive Earnings yield passive income through a low-risk portfolio of investments.
- Investment Earnings on your RRSP savings are also tax-free. Therefore you are able to compound your earnings and grow your wealth quicker.
- Annuity: You can convert your RRSP savings into regular periodic payments when you retire. Which could then feel like you are still earning a regular salary despite not having to go to work anymore.
- Spousal RRSP can reduce the combined tax burden on you and your partner. As well as grow your earnings on RRSP Investments quicker than individually.
What is The RRSP Contribution Limit?
Because RRSPs are tax-advantaged accounts, they are subject to certain rules. The most important of such rules is the cap on the amount that you can contribute in any given year.
As of 2020, the limit was pegged at 18% of your Past year’s income or $27,230 CAD, whichever is smaller. For 2021 the figure is $27,230.
The figure may increase annually to adjust for inflation, rising wage rates, and maintain relevance.
Reasons for RRSP Contribution Limit
- To avoid people living a low-quality life in fear of tomorrow, making them vulnerable members of society.
- To keep economic activity going through adequate consumption. Excessive Savings can lead to a drastic reduction in economic activity.
- Tax avoidance: The CRA (Canada Revenue Agency) ensures that individuals do not go over the limit to ensure that the RRSP does not become a tax avoidance scheme.
A drastic fall in tax revenue will limit the government’s ability to provide public amenities.
What Happens If you Contribute too Much to Your RRSP?
First, you will get a warning from the CRA. If you don’t conform, a 1% penalty on the amount over-limit will be levied on you monthly.
Can I make withdrawals from my RRSP Account?
Yes, you can withdraw from your RRSP account.
However, many bottlenecks are in place to discourage you from doing this. Most notably, you will be taxed on every withdrawal you make from your RRSP. However, there are some exceptions in form of the Home Buyers Plan.
Home Buyers Plan: By design, it is very difficult to withdraw funds from a retirement savings account. The whole idea of having an RRSP is to lock-up all the money for your future self. However, the Home Buyers Plan provides a notable exception to that idea.
The HBP is a program conducted through the CRA which allows first-time homeowners to make a Tax Free withdrawal of up to $35,000 CAD from their RRSP. This will be applied towards making a down payment on your (first home). If you already own a home, you will not be eligible to make such a withdrawal tax-free.
How Can Your Employer Encourage You to Make RRSP Targets?
Some employers encourage their workers to meet their retirement savings target through the Matching Contribution Plan.
Employers on the Matching plan will be obliged to make an additional contribution into the Employer’s RRSP account up to the amount that the Employee has indeed contributed for a month or year.
The effect of this is that the employee has doubled his contribution, tax-free. But it can even make a bigger difference in terms of compounding earnings over time.
The Matching Contribution plan goes a long way to encourage employees of a company to make consistent contributions to their RRSP accounts.
Conclusion
The RRSP savings figures today are at an all-time high. Experts have been exploring many options to explain the reason behind this trend.
- Firstly, according to an only public survey conducted by Pollara Strategic Insights, most Canadians desire to retire at between the ages of 60 to 62. The desire to retire much earlier is one of the reasons people are investing more in their RRSPs.
- People also want to retire with so much more money than before. Millennials believe they will need at least $1.5 Million CAD to retire comfortably.
- Another noticeable factor is that when people hit hard times, they prefer to rack up debts instead of withdrawing from their RRSP. Credit is much easier to obtain these days than ever before. Credit cards, soft loans, pay-later groceries etc. all mean that people no longer have to resort to RRSP withdrawals to meet up with short-term liquidity needs.
RRSP Tips
- Start Early
- Maximize your contribution but ensure to stay within the limit. This will help you avoid the 1% monthly penalty.
- Get a financial planner to help you work out your budget to help you meet up your RRSP contributions consistently.
- Monitor your balances and your progress.
- Lastly, ensure to set a data-driven retirement plan. You can make use of RRSP calculators such as The Royal Bank retirement savings calculator
