As a Canadian, your registered retirement savings plan (RRSP) is one of the best investment accounts that you have to save for retirement.
If there were trophies given out for best investment accounts for Canadians, the RRSP would get a large one.
The RRSP is a crucial account and could mean the difference of hundreds of thousands of dollars during your retirement due to tax savings.
I’ve written several smaller articles about the RRSP, and I wanted to combine everything I learned about them into one handy guide for you to follow.
What is an RRSP?
An RRSP is a savings plan that you or your spouse or common-law partner can contribute to. The main benefits of an RRSP are that all investments held inside of it will grow at a tax-free rate, and contributing to an RRSP reduces the amount of income tax you will have to pay that year.
What are the tax advantages of your RRSP
It’s important to keep in mind that an RRSP is not tax-free, but it is tax-deferred. But with the magic of continuous compounding, in the long term, this can add up to a very significant sum of money. Here are four ways you can save on taxes with your RRSP:
- Tax refund – If you pay your RRSP for the previous year before the deadline on March 1st, you are paying with after-tax income, and you will receive a tax refund as that amount will be deducted from your taxes calculated.
- Tax-deductible contributions – You can choose to pay your RRSP with before-tax income, meaning that the contributions will be taken out from every paycheque. This directly reduces the taxes you pay every paycheque.
- Tax-sheltered earnings – The income you earn on your investments in your RRSP will not be taxed. The main sources would be interest, dividend, and capital gains taxes.
- Tax-deferral – You will eventually have to pay taxes when you withdraw your RRSP. However, overall your investments will have grown much larger because you have deferred your taxes.
How does an RRSP work exactly?
If you are a Canadian and you have earned income, you are allowed to contribute to an RRSP for that tax year.
The amount that you contribute will be deducted from your income that year, meaning that you will get a tax refund based on your marginal tax rate. The higher the tax rate you have, the higher refund you will get.
It’s important to know how much your income is and how much your marginal tax rate is when figuring out how much to contribute to an RRSP.
For example, if you live in British Columbia and you make $100,000 per year, you will be paying a provincial tax rate of 12.29% and a federal tax rate of 26%. If you contribute to your RRSP, you will get a tax refund of 38.29% of every dollar you contribute until you are lower than your next marginal tax rate.
You can also choose to pay your RRSP directly from your paycheque, in which case your taxes will be reduced automatically throughout the year, and you won’t receive a refund.
RRSP deduction limits
The maximum deduction limit per year is the lesser of:
- 18% of your earned income for the tax year, and:
- The annual RRSP limit: The 2023 RRSP maximum contribution limit is $31,560
Every year, on March 1st or February 29, if it is a leap year, will be your RRSP deadline. 2019, for example, was not a leap year, so March 1st was the deadline.
Whatever RRSP limit you don’t use in any given year will be carried forward to the next years. This is your RRSP contribution limit, which differs from your deduction limit if you don’t contribute the maximum every year.
How to find out your contribution room?
Your latest notice of assessment (NOA) will have the amount you are allowed to contribute. If you are in doubt, you can contact the CRA at 1-800-959-8281 or log in to your online CRA account here.
What type of income counts towards an RRSP
Earned income mainly consists of but is not limited to:
- Employment income
- Self-employment income minus business expenses
- Rental income
- Alimony income
If there is a type of money you receive that you aren’t sure would qualify, make sure to check with the CRA.
Investments you can hold inside of an RRSP
Your RRSP is very versatile and can hold many different types of investments, such as:
- Mutual funds
- Exchange-traded-funds (ETFs)
- Savings deposits
- Treasury bills
- Guaranteed investment certificates (GICs)
- Put and call options
There are also ineligible investments that you aren’t allowed to hold in your RRSP. If your investments don’t fall within these categories and you aren’t sure, make sure to check the updated list of what you can hold in an RRSP to avoid penalties.
What should you invest in your RRSP?
Your RRSP should be viewed as a retirement account, and you should look at it as very long-term investing.
In my opinion, the best investments to hold in an RRSP should provide strong growth potential, beat inflation, and have low fees. Here are three of my investing principles when it comes to my RRSP:
- Determine what your appropriate mix of equities and bonds are for your age and risk tolerance. If you want a rough estimate, you can start with 100 – your age, and that can be your equity portion. For example, a 35-year-old could start with around 65% equities and 35% bonds. I personally have a very high-risk tolerance and am far from retirement, so I am invested 100% in equities. It really depends on your personal risk tolerance.
- Exchange-traded funds (ETFs) and stocks are my preferred investments for an RRSP since all of the accumulated dividends, capital gains, and interest income grow tax-free. There are also very low or no fees for holding each of these investments.
- I don’t invest in mutual funds, as Canadian mutual funds are known to have some of the highest fees in the world. A recent study by Barrons showed that Canadians pay the third-highest mutual fund fees in the world. The high fees usually lead to underperformance in the long term for the vast majority of mutual funds.
Deduct your RRSP directly from paycheque
I’m a big advocate of deducting your RRSP directly from your paycheque if your company allows it. Doing this is the best way to build good habits because it is automatically programming you to save.
If you don’t see the money in your bank account, you will adjust your spending levels almost subconsciously. Also, you get to see your tax savings immediately instead of waiting until the next year for you to get your refund.
How to withdraw your RRSP without paying taxes?
I have some bad news, and that is that you can’t withdraw your RRSP without some form of tax. Your RRSP is tax-deferred, not tax-free.
However, if you play your cards right, you can pay the minimum amount of taxes possible, which is the whole point of the RRSP. The following few sections outline ways you can withdraw your RRSP:
The age your RRSP expires and what you can do with it
Your RRSP expires in the year that you turn 71. These three options are:
- Withdraw your entire RRSP into cash
- Not a great option. Your income will increase by the entire amount for that year, and you will be taxed heavily on that amount.
- Use your RRSP to buy an annuity
- Not a great option. Annuity payments are tied to interest rates, and interest rates are very low right now; you will not be getting very good value for these annuity payments.
- Convert your RRSP to a registered retirement income fund (RRIF)
- Your best option. This option is essentially a continuation of your RRSP, except now you have the minimum required amounts that you need to withdraw each year. More will be explained in the next section.
Converting your RRSP into an RRIF
You must convert your RRSP to an RRIF in the year that you turn 71. You can also convert it earlier if your situation makes sense for that. The benefit of delaying withdrawing as late as possible means you can still get the benefit of deferring your taxes as late as possible.
Once you start withdrawing from your RRIF, the amount will be taxable. The tax rate is based on your current income level.
You can see the minimum percentage you must withdraw at each age at this link.
If you withdraw above your minimum amount, you will be charged with a withholding tax for the amount that you are over the minimum. Try not to withdraw above the minimum amount!
A neat trick you can do if you want to withdraw as little of your RRIF as possible is if your spouse is younger, you can use your spouse’s age to calculate the minimum withdrawal amount.
Early RRSP withdrawal and withholding taxes
Many Canadians will withdraw their RRSPs early in order to make purchases. This is almost always a terrible idea, in short, because you will be taxed to death, and you will lose out on the tax-deferral of the RRSP. Unless it is a life or death situation, avoid taking money out of your RRSP at all costs!
RRSP withholding tax
You can be hit with a withholding tax in the range of 10% – 30%, and even more if you live in Quebec because provincial taxes are taxed on also. You will also have to pay additional taxes if your marginal tax rate is larger than your withholding tax rate, or you could get a refund if it is lower.
You lose your contribution room if you decide to take out your RRSP early and can never earn it back again.
The government really doesn’t want you to take out your RRSPs early, and they are enforcing it with all of these negative consequences!
Early RRSP withdrawal without withholding taxes
There are, however, two programs with your RRSP that allows early withdrawal, where you won’t get hit with any withholding taxes:
RRSP Home Buyers Plan (HBP)
The HBP is a program where you can withdraw up to $25,000 from your RRSP to buy or build a qualifying home. There is a proposal to increase the amount to $35,000, but this has not yet been implemented. You will have 15 years to repay the amount withdrawn, with minimum payments due every year.
RRSP Lifelong Learning Plan (LLP)
The LLP allows you to withdraw up to $10,000 per year, to a maximum of $20,000 total from your RRSP. You can use the money for full-time training or education for you or your spouse or common-law partner. You must repay the amount withdrawn within 10 years, with minimum payments due every year.
After taking a close look at these two plans, even though they don’t have any penalties for early withdrawal from an RRSP, I’m not a big fan of them. I don’t like them because since you have to pay it back anyway, why not just leave your RRSP alone for what it was intended for, which was for retirement savings?
It’s best to train yourself to think of your RRSP as strictly for retirement savings and not touch it at all. If you need to save for a home or school, consider opening a high-interest savings account like one at EQ bank. With a current interest rate of 2.50% is a great option for short term saving.
RRSP vs TFSA: Which one should you choose?
There are many opinions about which you should start contributing first, the RRSP or your TFSA. In an ideal world, you would max out both of them every year, although this is not realistic for most Canadians.
Knowing what tax brackets you are in will help you to figure out how much to contribute to your RRSP. So which one should you choose? Here are a few things to keep in mind:
- If you are in a lower tax bracket, it certainly makes sense to max out your TFSA first before considering contributing to your RRSP. Because you are in a lower tax bracket, you won’t be benefiting as much from your RRSP tax refund. When you are making more money and in a higher tax bracket, that RRSP contribution room isn’t going anywhere, and you can still use it.
- A big exception to this is if your employer offers a matching Group RRSP program. In this case, always contribute the maximum amount, and choose the Group RRSP before the TFSA or regular RRSP. See the next section for why:
- I personally like to max out my TFSA every year, then I consider what tax bracket I am in for the amount I will contribute to my RRSP. I like the TFSA first because it is easier to predict than the RRSP. With the RRSP, there are a few uncertainties, such as you don’t know what will your tax rate be in the future, plus the government can raise taxes before the time you retire.
RRSP vs Group RRSP (GRRSP)
If your employer offers a matching contribution Group RRSP program, always contribute the maximum that you can to the GRRSP. The return you make on the Group RRSP is more than you can ever make in your TFSA or normal RRSP, because your employer will contribute a matching amount, usually between 50% – 100%.
I call this “free money”, and there are very few investments in your life that give you this opportunity. Take full advantage of this! Even though you will probably have to invest in a high-fee mutual fund, it is well worth it.
During my 7 years of working at Enmax, I contributed 4% of my income, and my employer matched 2% of it. I invested it in the equity mutual funds that were my options in the group plan at the time.
By the time I left Enmax, my investments were worth over $70,000, and I was free to move it into the investments of my choice. I immediately moved the entire amount into ETFs and stocks after I quit.
Contributing to a spouses RRSP
You have the option of contributing to a spouse or common-laws RRSP instead of your RRSP. The main benefit of doing this is if one partner makes much more than the other partner.
You can avoid a situation where one partner has a much larger RRSP, meaning that they will be taxed much more upon retirement because they will have a larger RRSP. By balancing out your RRSPs more equally, you can both pay a lower tax rate on retirement.
One thing to be wary of when contributing to a spouse’s RRSP is of the spousal attribution rule. To summarize this rule, all you need to know is if you are contributing to a spouse’s RRSP, for that spouse to not take out that amount from the spousal RRSP until after 3 years that it was entered in. If you take it out before, the income will be attributed back to the original spouse.
Penalties for RRSP over-contribution
If you contribute more than your RRSP limit allows you, plus $2,000, you will be hit with a 1% tax per month on your excess RRSP contribution. For example, if your Notice of Assessment (NOA) says you have $10,000 in your RRSP contribution room, you can actually contribute up to $12,000 until you are assessed a penalty by the CRA.
The $2,000 is a buffer that the government allows you for accidentally overcontributing. Savvy RRSP investors who contribute the maximum can take advantage of the $2,000 buffer but must be very careful not to go over that limit.
How much should you contribute to your RRSP?
A common question is how much RRSP should I contribute to avoid paying taxes? Well with the RRSP, you aren’t avoiding paying taxes, rather, you are deferring it until you start withdrawing it. The taxes you save will depend on your marginal tax rate at the time.
Know both your federal and provincial tax rates and that will tell you how much taxes you will get in your refund.
Borrowing to contribute to an RRSP
I’ll keep this section short and sweet. Yes, you can borrow to contribute to an RRSP. The main argument for this strategy is that interest rates are low, and your tax savings can be significant.
But I don’t recommend this approach. You’re putting yourself into debt willingly, which you will have to pay interest on. You’re better off saving more the next year than contributing what you can with cash instead of debt.
How to open an RRSP
There is no shortage of options when it comes to where you can open up your RRSP. You can open it up using a self-directed account like Questrade, an online investment manager such as Wealthsimple, an online bank like EQ bank or Tangerine, or a brick-and-mortar bank like RBC or Scotiabank. All of these establishments will be eager to help you open an RRSP with very helpful customer support.
You can also contact your financial institution, credit union, or insurance company for more information.