Are you planning for your retirement in Canada? In the United States, residents are allowed to contribute to a tax-deferred 401k account.
Their 401k can be used for savings and as an investment vehicle, giving them a steady income stream after they retire. Is there a 401k equivalent in Canada?
There are no 401(k) plans in Canada. Instead, Canadians can contribute to a tax-deferred Registered Retirement Savings Plan (RRSP).
Below, I’ll explain a bit more about how RRSPs work and how they differ from a 401k, how to contribute to them, what the annual contribution limits are, and how to factor an RRSP into your retirement planning.
Now, here’s a quick look at some of the key similarities and differences between 401(k) plans in the US and RRSP plans in Canada:
|Contribution limit (2023)||$20,500 (plus $6,500 catch-up for those 50+)||18% of earned income, up to a maximum of $30,780|
|Employer contributions||May offer a matching or non-matching contributions||May offer a matching or non-matching contributions|
|Tax treatment||Contributions are pre-tax, earnings grow tax-deferred, and withdrawals are taxed as income.||Contributions are tax-deductible, earnings grow tax-deferred, and withdrawals are taxed as income.|
|Withdrawal penalties||Withdrawals before age 59.5 are subject to a 10% penalty, with some exceptions.||Withdrawals before age 65 are subject to a withholding tax, with some exceptions.|
|Required minimum distributions (RMDs)||Must begin taking RMDs at age 72 (or 70.5 if born before July 1, 1949)||Must begin taking RMDs at age 72|
|Accessibility||It may be difficult to access funds before age 59.5||Can withdraw funds at any time, but tax and penalty consequences may apply|
|Investment options||Typically limited to options chosen by the plan sponsor||More flexibility in choosing investments|
|Portability||May be able to transfer to a new employer’s plan or an IRA||May be able to transfer to another RRSP or an RRIF|
An RRSP is one of two major retirement savings accounts in Canada. They are registered with and overseen by the Canada Revenue Agency (CRA) to ensure all accounts comply with tax codes.
You can open up an RRSP account with virtually any major bank and make regular contributions throughout the year (as long as it’s within your contribution room). Many employers may also match a percentage of their employees’ contributions, which can help your RRSP grow even faster.
Registered Retirement Savings Plans are one of the most common investment vehicles used for retirement planning. They can be used to hold the following assets:
- Guaranteed Investment Contracts (GICs)
- Government & Corporate Savings Bonds
- Mutual Funds
- Stocks & Securities
- Exchange Traded Funds (ETFs)
If you contribute to your RRSP throughout your career, you’ll not only be able to reduce your annual income taxes, but your contributions will also grow on a tax-deferred basis thanks to your investments.
If you contribute the yearly limit each year, you should be sitting on a sizeable nest egg by the time you reach retirement age.
Like other Canadian retirement plans, you can contribute to your RRSP whenever you want. The contributions you make are tax-deductible, which means that you can claim a tax deduction for your contributions when filing your income tax returns.
However, the majority of employee contributions come from earned income. You can automatically divert a percentage of your paycheque into your registered retirement savings plan, so you don’t have to think about it.
There is an annual contribution limit to be aware of, though. If you surpass the maximum contribution, the CRA will impose a penalty tax on the excess contribution amount until it’s removed or transferred from the account.
Each year, the Canadian government defines a set RRSP contribution limit. The same limit applies to all Canadians, regardless of age or income.
The contribution limits are represented by a maximum percentage of the individual’s gross income or a set monetary amount (whichever is the lower number of the two).
- In 2022, the maximum RRSP contribution limit was $29,210 or up to 18% of the individual’s earned income from the previous year.
- For 2023, the maximum you can contribute to your RRSP account is $30,780 or 18% of the earned income from the 2022 tax year.
Like tax-free savings accounts (TFSAs), The contribution room generally increases each year slightly to account for inflation and current economic conditions.
At this point, you may wonder, “What happens if there’s unused contribution room from the previous year?“
The good news is that any unused contribution room leftover from previous years can be rolled over into future years.
For example, if you only contributed $25,000 to your RRSP in 2022, then you would be able to contribute an additional $4,210 in addition to the $30,780 limit for the 2023 tax year (for a total of $34,990).
Now, let’s talk about what happens if you over-contribute to your RRSP.
Since the CRA oversees all RRSP accounts, they’ll know as soon as you over-contribute to your RRSP. If you go over-limit, you’ll likely receive a notification from the CRA or your bank notifying you of the excess amount.
There is a bit of leeway here, and you won’t have to pay any penalties if the overage isn’t more than $2,000.
However, if more than $2,000 over the limit is left in the account through the end of the month, then you’ll be charged a 1% fee on the overage amount per month. For example, if you’ve over-contributed by $5,000, then you’ll have to pay a $50 fee on that amount every month.
To avoid this fee, you’ll want to take the excess amount out of the account before the end of the month. If you still want to save the money, you may consider putting it into a high-interest savings account (HISA) or adding it to your TFSA account.
- Currently, EQ Bank is offering a 2.50% interest rate
Are RRSP Contributions Taxed?
Unlike a traditional savings or investment account, which are funded by after-tax dollars, money contributed to your RRSP is tax-advantaged (or tax-deferred).
This means an employee’s contributions are taken out of their paycheque before taxes. You’ll pay standard income tax on the remaining amount of your paycheque after your contribution.
Additionally, any profits within your RRSP aren’t subject to capital gains tax when they’re realized. Rather, once you begin withdrawing funds from your RRSP, they’ll be taxed at the standard income tax rate.
You can also choose to contribute to the RRSP after you are paid by your employer and claim a tax refund at the end of the year, but it’s much easier to deduct it from your paycheque instead.
RRSP holders can withdraw money from their account anytime, providing that it’s not a locked-in account (these aren’t as common).
However, if you withdraw funds before retirement, the amount will be added to your annual income, and you’ll have to pay taxes accordingly.
The extra taxes you’ll have to pay on this amount are the only early withdrawal penalties you’ll need to worry about. If you’re just withdrawing a small amount, this may not affect your tax obligation too much.
However, withdrawing a larger amount from your RRSP will mean you could end up paying higher income taxes than you anticipated, as it will count towards your income.
Note you will have to pay withholding taxes when withdrawing from your RRSP.
Here is a table outlining the withholding tax rates for RRSP withdrawals in Canada:
|Amount Withdrawn||Withholding Tax Rate|
|Up to $5,000||10%|
|$5,001 to $15,000||20%|
These withholding tax rates are not the final taxes you will owe on the withdrawal amount. The actual tax liability will depend on your marginal tax rate for the year in which you make the withdrawal, and you may owe additional taxes when you file your tax return.
There are two exceptions to this rule, where withdrawing your RRSP won’t count toward your income:
- To help pay for your first home (under the Home Buyers’ Plan)
- To help fund your education (under the Lifelong Learning Plan)
If you withdraw early for either of these reasons, the amount won’t be taxed. However, you’ll want to keep any receipts and records to verify that your RRSP withdrawal went directly into your first home or your education.
You can open an RRSP account as soon as you’re old enough to open a regular bank account (although some banks may require you to be majority-age).
You can continue contributing to your RRSP until you turn 71, up to December 31st. By this age, most Canadians have retired and are making regular withdrawals from their RRSP. However, if you want to continue contributing and saving, you’ll need to open up an RRIF account.
There are several different RRSP accounts that Canadians can open, including:
- Individual RRSP: This is the most common type of RRSP and allows individuals to contribute to their own plans and choose their own investment options.
- Self-Directed RRSP: This type of RRSP allows individuals to have more control over their investments by choosing from a wider range of investment options, including stocks, bonds, mutual funds, and exchange-traded funds (ETFs).
- Spousal RRSP: This type of RRSP allows one spouse to contribute to a plan in the other spouse’s name. The contributing spouse can claim the tax deduction, while the plan’s benefits are paid to the spouse whose name is on the plan.
- Group RRSP: Employer-sponsored retirement plans are RRSPs that are offered by companies to their Canadian employees. Contributions to the plan can be made by both the employer and the employees. The benefit of a group RRSP is that account management fees are lower (since they’re spread out among multiple members).
There’s no limit on how many RRSP accounts you can open as long as you abide by your annual contribution limit spread across all of your accounts.
For example, if your contribution room for 2023 is $30,780, this represents the total contribution limit for all of your RRSP accounts. It doesn’t mean that you can contribute $30,780 to each RRSP account.
If you’re enrolled in a group retirement savings plan and happen to leave the company you’re employed at, you’ll have several options:
- Leave the money in the account and allow it to grow. You’re still entitled to the amount you contributed, even if you left the company on bad terms.
- Transfer the funds to a group RRSP at your new company.
- Transfer the funds to an individual retirement account.
- Accept a cash withdrawal on the amount in your group RRSP (although this will come with tax penalties).
Consider each option’s fees, investment options, and tax implications before making a decision.
A Registered Retirement Income Fund (RRIF) is another retirement plan similar to an RRSP. However, the two retirement plans differ in the following ways:
- Purpose: An RRSP is designed for savings and accumulation of funds for retirement, while an RRIF is designed for providing retirement income.
- Withdrawals: Withdrawals from an RRSP are taxed as income when they are made. An RRSP must be converted to an RRIF by the end of the year in which the individual turns 71. RRIFs are required to make minimum withdrawals each year, which are taxed as income.
- Contribution Limits: An RRSP has set annual contribution limits, which are set by the Canadian government and adjusted periodically. An RRIF does not have contribution limits.
- Flexibility: RRSPs offer more flexibility for contributions and withdrawals, as contributions can be made until the individual turns 71, and withdrawals can be made at any time (although they’re subject to taxes and penalties). RRIFs have mandatory minimum withdrawal requirements.
Here’s a summary comparison table of the RRIF vs the RRSP:
|Feature||RRIF (Registered Retirement Income Fund)||RRSP (Registered Retirement Savings Plan)|
|Purpose||Provides income in retirement.||Saves for retirement.|
|Age limit||Must be converted from an RRSP by age 71.||Contributions must stop at age 71.|
|Withdrawals||Required minimum withdrawals must begin by age 72. Withdrawals are taxable.||Withdrawals are optional and taxable.|
|Taxation||Withdrawals are taxed as income.||Contributions are tax-deductible.|
|Contribution limits||No contribution limits.||Contribution limits are based on earned income and RRSP contribution room.|
|Contributions||No contributions are allowed.||Contributions are allowed up to the contribution limit.|
|Unused contribution room||An unused contribution room cannot be carried forward.||An unused contribution room can be carried forward.|
|Spousal plans||Spousal RRIFs are permitted.||Spousal RRSPs are permitted.|
|Estate planning||Beneficiaries can be named, and the funds can pass directly to them upon death.||Beneficiaries can be named, but the funds must be included in the deceased’s estate.|
FAQs About RRSP Accounts In Canada
To finish up, here are a few quick-fire answers to some of the most commonly-asked questions about RRSPs in Canada.
If you surpass your maximum contribution limit for the year by more than $2,000 and keep the overage in the account through the end of the month, you’ll be charged a 1% tax penalty every month until you remove the amount.
TFSA accounts are not tax-deferred accounts like RRSPs, and you won’t receive a tax deduction for your contribution. However, the funds can grow tax-free within the account, and you’ll never have to pay income tax on the amount withdrawn from a TFSA account.
The Registered Retirement Savings Plan (RRSP) in Canada is the closest equivalent to the 401(k) plan in the United States. An RRSP account allows your investments to grow tax-deferred so that you can retire with a steady stream of investment income.
Your RRSP can also be used to make a down payment on your first home or to help fund your education without tax consequences.
Are you ready to open up your first RRSP? Keep on reading to see my top-rated RRSP savings rates and banks in Canada!