People often mistake Registered Retirement Saving Plan (RRSP) for Retirement Saving Plan (RSP). Although they are both aimed towards retirement, they’re different. While a Retirement Savings Plan (RSP) refers to several retirement accounts, a Registered Retirement Saving Plan (RRSP) relates precisely to one account type.
One of the most significant tax advantages of an RSP is that the CRA can deduct any contributions from your income. Let’s take a look at RSP and what it entails.
Retirement Savings Plan
A Retirement Savings Plan is several different accounts that Canadians use to contribute and save money towards their retirement. Other RSPs include accounts like Tax-Free Savings Account (TFSA), a Registered Pension Plan (RPP), which have defined benefit pension plans, defined contribution pension plans, and non-registered (or taxable) accounts.
Depending on the type of plan you want to contribute towards, RSPs can include investments like stocks, bonds, mutual funds, ETFs, GICs, and saving accounts. You can register for any RSP via Canada Revenue Agency (CRA).
Contributions towards any of the plans are tax-deductible depending on the marginal tax rate when you fund your account. You can defer paying tax on the money in any of the plans and any interest it accrues until you withdraw it,
You can defer paying tax on the money and any interest it gains until you withdraw it, probably in retirement. When you make a withdrawal, the CRA will consider it as income, and you’ll be required to pay taxes on it according to your marginal tax rate at that period.
The RSP contribution limit for 2021 is 18% of earned income an individual report on their tax return in the past year, up to a maximum of CA$27,830. For those with a company pension plan, the CRA will reduce their RSP contribution.
The CRA automatically forwards any unused contribution room indefinitely. You can view your available space by checking your previous year’s Notice of Assessment. Bear in mind that the CRA will penalize you if you over contribute.
Currently, there is no starting age limit for RSP. Anyone that has earned income and file their tax return can contribute to an RSP the following year.
RSPs have no starting age limit – anyone that has earned income and filed a tax return can donate to an RSP the subsequent year. The CRA requires you to convert your RSPs to a Retirement Income Fund (RIF) by the end of the year your turn 71. When you do this, you must withdraw a certain amount of money from your RRIF yearly.
Types of RSPs
There are several types of retirement saving plans that come with their unique tax advantages. Below are some retirement plans, their features, and perks.
Registered Retirement Savings Plan (RRSP)
Registered Retirement Savings Plans are the most prominent RSP out there. This is because they offer some of the most attractive tax advantages. All contributions in this plan are deductible from your annual taxable income.
However, any earnings on savings or investment held within an RRSP are not taxable until you make a withdrawal. Within the RRSP, you can keep several assets, including savings account, GICs, stocks, bonds, mutual funds, and Exchange Traded Funds (ETFs).
Generally, within the RRSP, you can contribute up to 18% of your previous year’s earning. You can also forward any unused contribution to subsequent years.
Since RRSPs aim to provide a source of income in retirement, the CRA will penalize you if you withdraw funds before you retire. However, there are exceptions to this, like the Home Buyers Plan (HBP) and Lifelong Learning Plan (LLP).
These plans allow you to borrow a certain amount from your RRSP tax-free to help off your first home payment or pay for full-time post-secondary education. The CRA recommends that you convert your RRSP into a Registered Retirement Income Fund (RRIF) the year you turn 71.
Note that all RRSP/RRIF withdrawals, even in retirement, are subject to income tax. If you want to be in a lower tax bracket during retirement, then the RRSP is suitable for you as it is a tax-advantageous retirement savings plan.
Registered Pension Plan (RPP)
Often referred to as an employer-sponsored or corporate pension, a Registered Pension Plan (RPP) is a retirement savings plan that your employer establishes on your behalf. There are currently two types of Registered Pension Plans, they are:
- Defined Benefit (DB).
A defined benefit RPP is a specific monthly wage your employer promises to pay you in retirement. A calculator that calculates your age, years of service, and income level determines the amount due.
Often, an employer bears the entire pension cost, such as making all the donations and investing them on behalf of plan members. While in some other defined benefit plans, you may split contributions with your employer.
- Defined Contribution (DC)
A defined contribution RPP is like an RRSP. This plan allows you to choose how to invest your contributions and your pension income in retirement based on long-term goals. You can invest monthly contributions in your DC plan, which will be taken out of your paycheque. There is also a matching program where your employer contributes a percentage of your donation.
All contributions you make towards your RPP cut into your annual RRSP contribution room. This is also known as a pension adjustment, and the CRA automatically includes it in your RRSP contribution room calculation on your yearly tax assessment statement.
In a case where you leave your employer before retirement, you can either remain a member of the RPP and receive your pension at retirement or choose to collect a commuted value of the pension. If applicable, you can reinvest it in a Locked-In Retirement Account (LIRA) or another employer’s RPP.
Tax-Free Savings Account (TFSA)
Tax-free savings accounts are one of the most prominent registered accounts in Canada. A TFSA is not meant for retirement alone; you can use it for any purpose. All savings and investment earnings within TFSA are tax-free, and withdrawal is also tax-free.
It is an excellent way to increase cash flow in retirement while minimizing taxes and potential claw-backs on income-tested benefits like Old Age Security (OAS).
Like RRSPs, TFSAs can hold various assets like savings accounts, GICs, stocks, bonds, mutual funds, and Exchange Traded Funds (ETFs). TFSA contribution room is a regular annual amount for all individuals, and you can forward it to the next year if unused.
There are penalties if you overcontribute, though any withdrawals from a TFSA are added back to your contribution room in the subsequent year.
With TFSA, there is no tax deduction when you contribute but pay no income tax on withdrawals. TFSAs can be excellent retirement savings plans for people who expect to be in a higher bracket during retirement than in service.
A non-registered account is strictly not for retirement savings; it includes any savings or investment plan that is not held within a registered account, for example, RRSP, RDSP, TFSA, RESP, etc.
These types of accounts have room for additional income. If you have used all your contributions room for all applicable registered accounts, a non-registered account will give you other ways to invest and save your money and provide income in retirement.
However, non-registered accounts are not tax-advantageous; all investment or invest earnings garnered within them must be declared on your annual tax return as income. Nonetheless, for those eligible, their dividends and capital gains are taxed at a more considerable rate than interest income.
Currently, no contribution limits or rules are governing the amount or the period you must withdraw funds. This helps you save and invest longer. The fund in your non-registered account is liable to tax deductions if you borrow to invest. The interest charges on loan can be deducted from your annual taxable income.
Claiming RSP on Income Tax
You can claim RSP on your income tax, depending on the plan you invest your money in. If you contribute to an RRSP, you get a tax deduction that decreases your annual income by the amount of your contribution. Bear in mind that not all RSP contributions allow you to claim tax deductions.
For example, any contribution to your TFSA is made with after-tax funds; hence you don’t get an instant tax benefit on it. The perks come later when it’s time to withdraw the funds. Also, any interest within your TFSA is tax-free even upon withdrawal.
Any contributions made to non-registered accounts do not get any tax benefits. This is why most people usually use up their available RRSP and TFSA room before opening a non-registered account for investing purposes.
Although you cannot claim tax deductions for contributing to a non-registered RSP, there are other tax deductions like capital gains which the CRA tax at 50% of your marginal tax rate. Contrarily, you can use capital losses to offset capital gain by backdating it three years and forwarding it up to ten years.
Any contribution you make to an RRP impacts your RRSP contribution room via the pension adjustment (PA). Yearly, the CRA requires you to report your pension contributions and pension adjustment on your T4 slip. Below is a table showing which RSP is tax-deductible and which is not:[table “124” not found /]
There is no best retirement plan as each has its perks and is designed to complement each other. No plan currently offers everything you need; it is advisable to split out your savings and investment so they can come in handy when you need them – during retirement.