Beginner's Guide To RRSPs

More than sixty years after the federal government introduced the Registered Retirement Savings Plan as a vehicle to save for the future, RRSPs still remain one of the cornerstones of retirement planning for Canadians. In fact, as employer pension plans become increasingly rare, the ability to save inside an RRSP over the course of a career can often make or break your retirement.

Here’s a beginner’s guide to RRSPs:

The deadline to make RRSP contributions for the 2019 tax year is March 2, 2020.

Anyone living in Canada who has earned income can and should file a tax return to start building RRSP contribution room. Canadian taxpayers can contribute to their RRSP until December 31st of the year he or she turns 71.

Contribution room is based on 18 percent of your earned income from the previous year, up to a maximum contribution limit of $26,500 for the 2019 tax year. Don’t worry if you’re not able to use up your entire RRSP contribution room in a given year – unused contribution room can be carried-forward indefinitely.

Keep an eye on over-contributions, however, as the taxman levies a stiff 1 percent penalty per month for contributions that exceed your deduction limit. The good news is that the government built in a safeguard against possible errors and so you can over-contribute a cumulative lifetime total of $2,000 to your RRSP without incurring a penalty tax.

Find out your RRSP deduction limit on your latest notice of assessment or online using CRA’s My Account service.

You can claim a tax deduction for the amount you contribute to your RRSP each year, which reduces your taxable income. However, just because you made an RRSP contribution doesn’t mean you have to claim the deduction in that tax year. It might make sense to wait until you are in a higher tax bracket to claim the deduction.

When should you contribute to an RRSP?

When your employer offers a matching program: Some companies offer to match their employees’ RRSP contributions, often adding between 25 cents and $1.50 for every dollar put into the plan. Sadly, many Canadians fail to take advantage of this “free” gift from their employers – giving up a guaranteed 25-to-150 percent return on their contributions.

When your income is higher now than it’s expected to be in retirement: RRSPs are meant to work as a tax-deferral strategy, meaning you get a tax-deduction on your contributions today and your investments grow tax-free until it’s time to withdraw the funds in retirement, a time when you’ll hopefully be taxed at a lower rate. So contributing to your RRSP makes more sense during your high-income working years rather than when you’re just starting out in an entry-level position.

RelatedA sensible RRSP vs. TFSA comparison

A good rule of thumb: Consider what is going to benefit you the most from a tax perspective.

When you want to take advantage of the Home Buyers’ Plan: First-time homebuyers can withdraw up to $35,000 from their RRSP tax free to put towards a down payment on a home. Would-be buyers can also team up with their spouse or partner to each withdraw $35,000 when they purchase a home together. The withdrawals must be paid back over a period of 15 years – if not, the amount is added to your taxable income for the year.

Beware of raiding your RRSP early

Unless it’s a dire emergency then it’s generally a bad idea to withdraw from your RRSP before you retire. For starters, you have to report the amount you take out as income on your tax return. Not to mention you won’t get back the contribution room that you originally used.

To make matters worse, your bank will hold back taxes – 10 percent on withdrawals under $5,000, 20 percent on withdrawals between $5,000 and $15,000, and 30 percent on withdrawals greater than $15,000 – and pay it directly to the government on your behalf. That means if you take out $20,000 from your RRSP, you’ll not only end up with just $14,000 but you’ll have to add $20,000 to your income at tax time.

What kind of investments can you hold inside your RRSP?

A common misconception is that you “buy RRSPs” when in fact RRSPs are simply a type of account with some tax-saving attributes. It acts as a container in which to hold all types of instruments, such as a savings account, GICs, stocks, bonds, REITs, and gold, to name a few. You can even hold your mortgage inside your RRSP.

If you hold investments such as cash, bonds, and GICs then it makes sense to keep them sheltered inside an RRSP because interest income is taxed at a higher rate than capital gains and dividends.

A good approach, depending on your age and stage, is the tried-and-true balanced portfolio consisting of 60 percent stocks and 40 percent bonds. You can achieve this mix with one balanced mutual fund, one balanced ETF, or a couple of low cost index funds or exchange-traded funds (ETFs).

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6 Comments

  1. Jerri on January 21, 2019 at 7:00 am

    Is the withholding tax paid to the goverment on withdrawls a non-refundable payment, or is it considered as payment towards your total income tax and will be refunded if you owe less than you paid?

    • Robb Engen on January 21, 2019 at 2:23 pm

      Hi Jerri, it’s a payment towards your total income tax – no different than your employer withholding an amount on your paycheque for taxes.

      • Jerri on January 21, 2019 at 3:34 pm

        Thanks!

  2. Gus on January 21, 2019 at 8:29 pm

    Hi Robb ! Thank you so much for your time and effort .
    for a guy who makes about 60k a year would it make more sense to contribute to rrsp or tfsa ? i currently have only an rrsp account but i’m thinking of depositing the tax refund check into my tfsa and grow it tax free , i know the wealthy barber wrote about this that it won’t make any difference as long as you reinvest your tax return back in rrsp.
    Thanks

    • Robb Engen on January 23, 2019 at 4:17 pm

      Hi Gus, the answer to your question depends on your marginal tax rate. What province do you live in?

      For example, $60k in Ontario puts you at a 29.65% marginal tax rate, meaning that you’d get a refund of about $300 on every $1,000 contribution to your RRSP.

      As for where to put your tax refund, here’s an article with a few tips to supercharge your RRSP: https://boomerandecho.com/what-does-pasta-have-to-do-with-rrsps/

  3. John Day on August 24, 2019 at 5:57 am

    Hello

    If I sell stocks held inside my registered RRSP, do I have to pay Capital Gains tax on the proceeds in the year that I sell them?

    I sold some stocks this year and withdrew the cash to pay down some debt. I paid the withholding tax of 20%.

    When I file my 2019 Income Taxes, do I need to include any Capital Gains realized for tax purposes on the stock I sold inside my RRSP?

    Thanks you

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