What is an RRSP?
A Registered Retirement Savings Plan (RRSP) is a special type of investment account which allows contributors to receive an immediate tax deduction from their income tax calculation, and then accumulate any investment returns within the plan tax-free. Only when the money is withdrawn from the plan does it become taxable in the hands of the plan owner. It is a very attractive and flexible tax shelter which is available to all Canadian taxpayers.
RRSP’s can hold many types of investments
There is a common misconception that RRSP’s can only be invested in term deposits or savings accounts which pay low rates of interest. In fact, when you open an RRSP you are able to invest in many things such as stocks, mutual funds, ETF’s etc. I often advise my clients to consider investing in a balanced and diversified portfolio of stocks and bond funds but every client is different in terms of their needs for returns and their comfort with risk.
Tax planning strategies using RRSP’s
RRSP’s are much more than just a way to save for retirement – there’s many other situations where having an RRSP can help. For example, if you contribute to a plan in when your earnings are high, you can use the money to support you during any break from employment such as maternity leave or a layoff. You can also take money out of an RRSP, tax-free, to go back to school or to use as a downpayment for some real estate (first-time homebuyers only) – but you are required then to pay this money back to the plan gradually. And, a spousal RRSP lets a high-income earner contribute to their lower-income spouse’s plan, which can significantly lower the overall income tax the couple must pay plus allows the high-income earner to claim a 100% deduction on the amount contributed.
Who can contribute to an RRSP?
If you have earned income, have a social insurance number and have filed a tax return, you can contribute to an RRSP up until December 31 of the year you turn 71. A similar rule applies to a spousal RRSP.
There are some limits on how much can be contributed to an RRSP – the maximum contribution to an RRSP for any year is 18% of your earned income, up to a certain maximum. In 2020 the contribution limit was set as $27,230. For most people, earned income for RRSP purposes is the amount in box 14 of their T4 slips. Earned income also includes self-employed net income, CPP/QPP disability payments and net rental income. If you have a company pension plan, then the contribution limit is reduced by an amount know as the pension adjustment which will appear on your T4 slip. Unused contributions carry forward indefinitely, so people who have been earning for several years but not contributing to any RRSP’s are often able to contribute a significant lump-sum to an RRSP.
When do I withdraw from an RRSP?
Funds can be withdrawn at any time, but keep in mind that what you withdraw will normally be taxable. The exceptions to this are withdrawals for education or real estate downpayment for first-time homeowners. Once you reach the age of 71, you are required to convert the RRSP to a Registered Retirement Income Fund. This allows you to continue to accumulate tax-free gains within the plan, but you are required to withdraw a minimum of 5% of the value of the plan every year. If your plan is earning a 6% return, its value will still be growing even as you’re taking your retirement income out!
Getting Started
RRSP’s are a very important tax planning tool, especially for high-income earners. The deadline for contributions which can be applied to your 2020 tax return is just two weeks away. Please contact me if you would like to discuss how they might fit with your personal situation or to learn more.
About Me
Lisa Ko, Licensed Insurance Advisor – I have been helping my clients for more than 10 years with their personal financial needs, including RRSP’s, RESP’s, TFSA’s and non-registered investments. I also work with companies and individuals to help them deal with life risks through insurance products and employment benefit plans.
