What is a RRSP? Registered Retirement Savings Plan

**This post may contain affiliate links. I may be compensated if you use them.

Have you ever wondered what is a RRSP? It stands for Registered Retirement Savings Plan. This type of account is used by millions of Canadians and is easily the most popular vehicle for those that are looking to save for their retirement.

While the concept of an RRSP is simple, what confuses people are the rules that come with the account. Yes, you get some great tax advantages with the account, but you also need to be aware of your contribution limits, withdrawal rules, and how the account works before you start investing.

What is a RRSP?

An RRSP is a registered account that Canadians can open and contribute to for retirement savings up to the age of 71. What makes RRSPs appealing is that for every dollar you contribute, your taxable income is reduced by an equal amount.

For example, let’s say that your taxable income for the year is $70,000 and you contributed $10,000 to your RRSP for the year. That means your total taxable income would actually be $60,000. 

Since RRSP contributions lower the income tax you owe, you would likely get a tax refund from the Canada Revenue Agency (CRA).

Additionally, any capital gains or interest earned within your RRSP are completely tax-free. You would only pay taxes when you withdraw the funds. The assumption is that you would only withdraw money in your retirement years after you’ve converted your RRSP to a Registered Retirement Investment Fund (RRIF). Most people are in a lower tax bracket when they retire, so their overall tax burden would be lower since they had invested in their RRSP in earlier years when their income was higher. 

RRSP vs. RSP

Some financial institutions use the term RSP (Retirement Savings Plan) when referring to an RRSP. They’re the same thing as both are registered with the Federal Government. Just because they don’t use the extra “R” in their documentation doesn’t mean it’s not registered.

What investment products can be purchased in a RRSP?

Some people that research what is a RRSP are surprised to find out that you don’t buy RRSPs. Think of your RRSP as an investment vehicle. You would then purchase investment assets that would be held within your RRSP account. These types of investments could include:

  • Cash – You would deposit cash into your RRSP before making your investment decisions. Some people will leave some cash in their RRSP to take advantage of any buying opportunities that come up. 
  • Guaranteed Investment Certificates (GICs) – GICs are a very safe product where your principal investment is guaranteed.
  • Mutual funds – This investment product pools money from different investors. The fund manager then uses the money to purchase different investment securities based on the goals of the mutual fund.
  • Government and corporate bonds – Bonds are another relatively safe investment since they can give you a fixed rate of return. That said, there are some poorly rated bonds that could be risky. 
  • Stocks – You can purchase individual stocks within your RRSP that could give you growth and dividends. That said, there’s always a chance that stocks could decrease in value.
  • Exchange-traded funds (ETFs) – ETFs are similar to mutual funds in the sense that it’s a single product that has different investments inside it. The major difference is that ETFs track an index instead of using a fund manager. With this strategy, ETFs charge a lower management expense ratio (MER) compared to mutual funds.

How to open a RRSP

An RRSP can be opened through a bank, credit union, or insurance company after you’ve earned income and have filed a tax return. There’s no minimum age requirement to open an RRSP, but many financial institutions do require you to be the age of majority. The only other requirements are that you’re a Canadian resident.

Most people set up an individual RRSP. However, it is possible to open an account for your spouse or common-law partner. This is known as spousal RRSP. This is beneficial to couples where one partner has a significantly higher income than the other.

To open up your RRSP, you can do one of the following:

  • Go to a branch – All financial institutions that have a physical location will have staff available to help you open an RRSP. They’ll also be able to recommend some funds so you can start investing right away.
  • Call your financial institution – You can open an RRSP over the phone. Note that you would have to be an existing client at the financial institution first. 
  • Do things online – Some digital banks operate online only. You could still open an RRSP with them online, but you’d likely have to scan and send over some documentation to open your account.

Once your account is set up, you can contribute money to it. Some people will opt to set up pre-authorized debits so they’re regularly investing. Alternatively, you can make lump sum deposits whenever you have some extra cash available. 

It’s also worth mentioning that you don’t have to use an investment advisor to manage your RRSP. You can open an account online with a discount brokerage and go the do-it-yourself route. This has become a very popular method as of late since it can lower your management fees significantly. Admittedly, this option is often better for people who have some experience investing.

RRSP contribution room

RRSP contribution room is only earned after you’ve worked and filed your taxes. The amount of RRSP contribution you earn is based on 18% of your earned income from the previous year. 

For example, if you earned $50,000 in income, your RRSP contribution room earned for the next year would be $9,000.

Also, note that there is an annual RRSP limit. For the 2021 tax year, the annual limit was $27,830.

Besides the annual contribution limits, there are a few things to consider when understanding what is a RRSP.

RRSP contribution limit carry forward

Any unused contribution room is carried forward indefinitely. For example, let’s say you didn’t use $5,000 of your contribution room. The following year you earned an additional $10,000 in contribution room. That would give you a total of $15,000 in RRSP contribution room available.

RRSP over-contribution

In the event that you over-contribute to your RRSP, you have to pay a tax of 1% per month on the excess contributions until you withdraw the excess amount. That said, you can exceed your RRSP deduction limit by $2,000 without having to pay any penalties. 

RRSP pension adjustment

Employees with a defined benefit pension will get a pension adjustment. This adjustment would reduce the amount of RRSP contribution room you have available. While this may seem unfair, it’s actually meant to make things fair for people who don’t have a pension.

RRSP deadline

The deadline to contribute to your RRSP is 60 days after the end of the year. That typically means the RRSP deadline falls on March 1. Any contributions made during the first 60 days of the year can be used for the previous tax year or your current tax year. 

For example, let’s say you contribute $5,000 to your RRSP on February 1, 2022. You could claim that amount when filing your 2021 taxes or you could claim it on your 2022 tax return.

RRSP withdrawal rules

Technically speaking, you can withdraw your funds at any time, but there may be tax consequences involved. Generally, most people will only withdraw from their RRSP after they’ve converted it to a Registered Retirement Income Fund. You have until December 31 of the year you turn 71 to convert your RRSP to an RRIF.

Once you’ve converted to an RRIF, you’re obligated to withdraw a minimum amount from your account each year. The amount withdrawn would then be considered income and taxed and your marginal tax rate.

RRSP Withdrawal withholding tax

In the event that you need to withdraw funds from your RRSP early, your financial institution would be required to withhold the following amounts for tax purposes:

  • 10% (5% in Quebec) on amounts up to $5,000
  • 20% (10% in Quebec) on amounts over $5,000 up to including $15,000
  • 30% (15% in Quebec) on amounts over $15,000

The above applies to Canadian residents. If you live in Quebec, there would also be an amount held for provincial taxes. For non-residents, a 25% withholding tax is applied on all amounts.

Even though money will be held for taxes, you may still owe additional taxes depending on your tax obligations for the year when you file. In addition, you would lose the contribution room permanently for any early RRSP withdrawal you make.

Home Buyers’ Plan

If you’re a first time homebuyer, you can withdraw up to $35,000 from your RRSP tax-free to help pay for your home thanks to the Home Buyers’ Plan (HBP). That said, the money does need to be repaid over 15 years. Any amounts that don’t get repaid would count as income and you’d lose the contribution space permanently.

Lifelong Learning Plan

The Lifelong Learning Plan (LLP) allows you to withdraw up to $10,000 tax-free in a calendar year to help you pay for your full-time students. You do need to pay the funds back over a period of 10 years.

Transfer to Tax-free First Home Savings Account

Another option for your RRSP is to transfer it to your Tax-free First Home Savings Account (FHSA). Although the program doesn’t launch until 2023, you’ll be able to transfer up to $8,000 a year from your RRSP until you reach the cap of $40,000.

The benefits of investing in a RRSP

By now you likely know what is a RRSP, but you’re probably wondering if it’s right for you. To simply put it, an RRSP is an excellent account since it provides the following benefits:

  • Tax-deductible – For every dollar you contribute to your RRSP, you get an equal tax deduction. This can lower the amount of tax you pay and may even result in a tax refund
  • Tax-deferral – Interest and capital gains made from your investments within your RRSP are tax-free until you withdraw the funds.
  • Contributions carry forward – Any unused RRSP contribution space gets carried forward to future years.
  • Can be used for other things – You can use the money within your RRSPs to fund the purchase of your first home or pay for continuing education.
  • Income splitting – A spousal RRSP could help couples reduce their overall tax obligations.

RRSP alternatives 

There’s no denying the advantages of an RRSP, but it’s not the only account you have access to. Which account you use should be based on your individual circumstances and goals.

Tax-Free Savings Account

A Tax-Free Savings Account (TFSA) is something that Canadian residents that are at least the age of majority have access to. You don’t get a tax deduction on contributions, but all investment earnings are completely tax-free. That means when you withdraw your money, no taxes are paid. There will always be a debate between RRSP vs TFSA, which is better. Generally, if you make less than $50,000, you’re better off investing in your RRSP instead of your TFSA. That’s because the tax benefits you get from an RRSP contribution don’t benefit you much when you have a lower income. You’re better off contributing when you’re in a higher tax bracket. 

Tax-free First Home Savings Account

If your goal is to buy your first home, the FHSA is arguably the best account to use. That’s because the FHSA combines the tax benefits of an RRSP and TFSA. You get a tax deduction on contributions and any capital gains you make are completely tax-free. The catch is that you can only contribute $8,000 a year up to $40,000. Unused contributions do not carry forward. You also have 15 years from the time you open the account to use the funds. The FHSA becomes available in 2023.

High-Interest Savings Account

High-Interest Savings Account (HISA) shouldn’t be used for retirement savings since the interest you’ll earn likely won’t be inflation. That said, if you’re looking for a place to park your money with no risk of it declining in value, then a HISA might be the best option. 

What is a locked-in RRSP?

A locked-in RRSP is more commonly known as a locked-in retirement account (LIRA). A LIRA is required if you leave an employer that has a defined benefit pension plan. Basically, a portion (or all) of what you’ve accumulated in your pension would be transferred to a LIRA. Once the money is in a LIRA, you would purchase investment products.

This is required since a DB pension is a type of locked-in retirement account. Although a LIRA won’t give you a fixed payment when you retire, you can use the account to invest your retirement savings.

Is an RRSP worth it?

Now that you know what is a RRSP, you’re likely wondering if an RRSP is worth it. In most cases, opening an RRSP is a great idea. Not only will it help you save for your future, but you’ll also get a tax deduction for your contributions. To maximize your RRSP, you should contribute regularly and invest your money. Over time, your savings will grow which will fund your retirement years.

About Barry Choi

Barry Choi is a Toronto-based personal finance and travel expert who frequently makes media appearances. His blog Money We Have is one of Canada’s most trusted sources when it comes to money and travel. You can find him on Twitter:@barrychoi

Leave a Comment





Get a FREE copy of Travel Hacking for Lazy People

Subscribe now to get your FREE eBook and learn how to travel in luxury for less