The RRSP or Registered Retirement Savings Plan is a special type of financial account in Canada that is used to hold savings and investment assets.
It was introduced in 1957, at a time when the defined benefit pension plan was still the commonly used retirement savings vehicle, wherein your employer pays you a regular sum of money when you retire. Since then, RRSP has become a helpful retirement planning tool for Canadians.
How does RRSP work?
RRSP is essentially a savings and investment account that allows you to save money for your retirement by making cash contributions or by holding investments in your RRSP in the form of stocks, bonds, GICs, or mutual funds.
One of the major benefits of using an RRSP is that any income that you earn within the RRSP is tax-free. This special tax treatment from the Canada Revenue Agency allows your savings and investments to grow tax-free.
Say, you earn $100 capital gain from selling Tesla shares. If you put that in a regular cash account or margin account, you have to pay taxes on that. In comparison, if you held that Tesla shares in your RRSP account, your $100 would not be taxed at all.
So, any income you earn within your RRSP account, whether it’s capital gains, stock dividends, or interest from bonds, is sheltered from tax. With this kind of retirement plan in place, you have more money to invest or compound over time.
On top of being a tax-sheltered retirement plan, RRSP is also a tax-deferred account where you are allowed to defer income tax for a future year through tax deductibles.
This means that the amount of money you contribute to your RRSP can be deducted from your taxable income. But keep in mind that when you eventually withdraw money from your RRSP account, the withdrawals must be included in your taxable income for the current year.
Why is this a good thing? It lowers your taxable income and saves you some money on taxes during your high-income, high-tax bracket years. You can use those savings for investment, then a few years down the road, when you’re near retirement and in a much lower tax bracket, you can pull the money out from the RRSP and pay a much lower amount of taxes.
What are the types of RRSPs?
There are three different types of RRSPs. The choice of RRSP would depend on your current status, financial circumstances, and how you want to structure and manage the RRSP account.
- Individual RRSP
This is the most common type of RRSP, wherein the account is registered in your name. As such, all the contributions and investments belong to you as well as the tax benefits and advantages associated with the account.
You can open a self-directed RRSP if you want more control over the creation and management of your RRSP investment portfolio. With this type of RRSP, you have an active role in choosing and managing the investment mix that would maximize your capital gains and minimize your taxes.
Self-directed RRSP is suitable for you if you want access to a wider range of investment options that are typically available to banks, brokerages, and fund managers.
- Spousal RRSP
A spousal RRSP is registered in your spouse’s name or common-law partner’s name. Although your spouse owns the investments held in the RRSP, you can contribute to the account. You get tax deductions whenever you make a contribution. But keep in mind that your own RRSP deduction limit for the year is reduced when you make any contribution.
A spousal RRSP is recommended if you want to split the funds more evenly upon retirement. This is particularly applicable if you earn more money than your spouse and you’re like be in a higher tax bracket when you retire.
- Group RRSP
This is an employer-sponsored RRSP typically offered by employers to their employees to help them save for retirement. The RRSPs of the employees are held and managed at the same bank or financial institution.
In Group RRSP, you will have to open an individual RRSP account, but your contribution is made through regular salary deductions. You determine the amount of contribution. Although the types of investment are quite limited, you can choose the one that best suits your investment risk tolerance.
Your employer has the option to match your contribution or add to it if they want to. Fees associated with opening and managing the account are usually paid by your employer but you pay for the investment costs.
Group RRSP is optional and it’s up to you to decide whether you want to participate or not. What’s good about Group RRSP is that you get immediate tax savings because your regular contributions are deducted from your taxable income straight away. All your earnings from investments are tax-sheltered as well.
Group RRSP is recommended if you want the consistency of a regular savings plan and you see yourself staying in the company for a long time or until retirement age.
RRSP Account – How to Get Started
To set up an RRSP, you would have to open an account through a financial institution. It can be a bank, an insurance company, a credit union, or a trust company.
Step 1: Learn about the different types RRSPs.
Knowing the types of RRSPs will help you make an informed decision on the best way to save up for your retirement. You can choose from individual, self-direct, spousal, or group RRSP.
Step 2: Talk to banks and financial institutions that offer the type of RRSP you desire.
Compare and contrast the plans and the fees associated with opening and managing the RRSP account. Ask them about their investment options.
Step 3: Decide on how you want your savings to be invested.
Typically, your investment options include, but not limited to, savings, stocks, bonds, GICs, mutual funds, and ETFs. Some plans only allow you to hold mutual funds and GICs. If you are a knowledgeable investor and want more investment options, you can opt for the self-directed RRSP.
Step 4: Choose the RRSP and the financial institution that has the best offer.
Armed with all the information you have researched; you can now choose the RRSP that best suits your current financial position and the financial institution that you believe will help you achieve your retirement savings goals.
Step 5. Complete the RRSP application.
To open an RRSP account, you need to bring two acceptable identifications (one must be a government ID). The bank will ask you questions about your financial situation, investment goals, salary earned in the previous year, beneficiaries, and pension plans. They ask these questions to know how much you can contribute to the RRSP and the factors that can affect your RRSP in terms of maximum deduction and contribution room.
Step 6. Make a contribution.
To officially open the RRSP account, you have to make a cash contribution to fund the account. You can also transfer funds from an existing RRSP. At this point, you can decide if you want to set up a regular contribution arrangement either through pre-authorized debit or a payroll savings plan in lieu of an annual contribution in one go.
Make sure to keep copies of your application as well as records of your investments and tax receipts from your RRSP contributions. Once you’ve completed these steps, you’re well on your way to achieving your retirement goals.