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An RRSP or Registered Retirement Savings Plan is something that most Canadians have heard of, but very few really understand. As the name implies, an RRSP is used to help Canadians save for their retirement, but that’s where most people's understanding begins and ends, meaning that they aren’t well informed enough on what an RRSP actually is, or what purpose they serve, to decide if an RRSP is something they should be investing in.
If this sounds like you, no worries, we have you covered. This comprehensive guide will get you up to speed and give you a solid understanding of the what, why, and how of opening and maintaining an RRSP of your very own.
What is an RRSP?
As we’ve already mentioned, a Registered Retirement Savings Plan is an account used to help Canadians secure savings for their retirement, but there is a lot more to know about them. RRSPs are savings and investment accounts established by Canadians through their financial institution, credit union, insurance provider, or a private broker that will then be registered with the government. RRSPs can be used in combination with or in place of a traditional pension plan to provide you with the money you need to live comfortably through retirement..
How does an RRSP Work?
RRSP accounts purchased through banks and financial institutions are most frequently a pre-bundled group of investments such as mutual funds, but you can also open empty RRSPs through a broker or investment firm and fill them with the investments you choose. The income and investments you put into your RRSP can be deducted from your annual income to reduce the amount you pay in income tax, and the gains made within the account are also tax-free, meaning you get to keep all of the profits you make within the account.
It is important to note that unlike other government-sponsored savings initiatives, like TFSAs, RRSPs are not actually tax-exempt, but tax-deferred. While you do not have to pay income tax on the amounts you deposit upfront, you will be taxed when you withdraw from your account, this also applies to any gains you make within your RRSP.
You can mitigate the taxes you will face by withdrawing from your account over a longer period of time, or converting the account into a Registered Retirement Income Fund or annuity when you reach 71 years old. You will still be taxed on any payments you receive from your converted account, but the idea is that you will pay less tax overall as you are likely to be in a lower tax bracket during retirement.
Who is eligible to open an RRSP?
Any person who has filed an income tax return within Canada for income earned within the country can open a Registered Retirement Savings Plan. The account will remain open and eligible to receive contributions until December 31 of whichever year they reach 71 years of age.
How to open and contribute to your own RRSP
Opening an RRSP is simple, if you meet the eligibility requirements listed above, all you need to do is visit your bank or credit union, or speak to your insurance company or private broker, to open an account. Whichever route you choose, your account provider will walk you through the RRSP account options you have with them and explain the investments they can hold.
RRSPs opened through financial institutions are generally pretty controlled, both in the types of investments, you have access to and the ways you can contribute and manage your funds. Opening an account this way will provide you with a pre-packaged set of investments determined based on the offerings of the financial institution. There is nothing wrong with this option, but it doesn’t offer you much control over your financial future.
If you would prefer to build and manage your own investment portfolio within your RRSP, a self-directed account is a better option for you. Some banks, credit unions, and insurance companies do offer self-directed RRSPs as an option and will simply take care of the administrative details and registering your account. Generally, you will want to go through a broker or investment firm for this type of account, we recommend Questrade, Tangerine, and Wealthsimple for your RRSP, and we will walk you through the services each of them provide later on.
What are the advantages of maintaining an RRSP?
RRSPs offer a number of benefits, mostly tax-related, to the Canadians who hold them. When making deposits into your RRSP, you are removing the contributed income from your annual taxable income and reducing the amount of taxes you pay for the year. Additionally, you are not taxed on any gains you make on investments within your RRSP account, but as we mentioned earlier, an RRSP is not actually a tax-free account, rather a tax-deferred investment vehicle.
You will have to pay taxes on any funds you withdraw from the account as part of your income tax for the year that you make the withdrawal. This can be a real issue for seniors who are living off limited income, such as their pension and RRSP withdrawals, so you will need to plan ahead to avoid being hit with a large lump sum of taxes.
What types of RRSPs are available?
There are four types of Registered Retirement Savings Plans for you to choose from, each with their own advantages and stipulations.
An individual RRSP is the most common account type, Individual RRSPs are registered to your name, with all of the contributions, investments, and benefits belonging solely to you.
A spousal RRSP is an account that you open but that will be registered to your spouse's name. Any contributions or investments made in the account will go to your spouse as the account holder, but they will not impact the contribution limits on any other RRSP accounts that they hold personally. The tax benefits on a spousal RRSP belong to the contributor.
A locked-in RRSP, also known as a Locked-in Retirement Account or LIRA, is an account only available in some provinces to those who leave their jobs before retirement. The locked-in RRSP allows you to take over the management of your invested funds or pension.
A group RRSP is an account type offered by some employers in which the company automatically deducts and deposits RRSP contributions from employee pay into the individual accounts it manages as a collective.
Self-directed RRSPs can be either Individual or Spousal RRSP accounts, with the difference being that they are empty when you open them so that you can choose and manage your own investments.
What type of investments can you hold in Your RRSP?
There are a wide variety of investments you can hold in your RRSP, with accounts opened through banks and financial institutions your account will typically be comprised of a pre-packaged bundle of investments, usually limited to mutual funds, and your future contributions are restricted by your bank's offerings and RRSP guidelines.
Should you opt to open an empty RRSP through a broker or independent financial advisor, you will have many more investment options available to you including:
- Bonds (such as corporate bonds, government bonds, and strip bonds)
- Canadian mortgages
- Canadian and foreign stock equities
- Exchange-Traded Funds (ETFs)
- Gold and silver bars
- Guaranteed Investment Certificates (GICs)
- Income Trusts
- Mortgage-backed securities
- RRSP eligible Mutual funds
- Savings bonds
- Treasury bills
This is just a sampling of the most common and popular RRSP investment options, you will want to speak to your broker or a financial advisor to determine the best type or combination of investments for you.
Should you modify your RRSP investments over time?
It is considered good practice to regularly modify your RRSP investment portfolio as you age, with consideration for the risk your investments hold. The general idea is that the older you get and the closer you are to retirement, the safer you want your investments to be.
For example, if you open your RRSP in your 20s, it would be fine for you to have a majority, up to roughly 60% of your investments in riskier options such as equities, as you can potentially maximize your gains but you also have plenty of time to recover your assets if your stocks take a bad turn. This is considered a relatively safe strategy to carry through until you reach your 40s, though you should still meet with your broker or financial adviser to review your portfolio on a semi-regular basis and make adjustments as needed.
As you grow nearer to the age of retirement, you should transition into more stable “guaranteed” investments, even if your potential return is much lower. You don’t want to keep a risky portfolio when a single bad year could seriously impact your retirement savings and quality of life when you need the money the most.
How much can you contribute to your RRSP?
The exact contribution amount for an RRSP varies from person to person, considering a variety of factors. Each year your contribution will be whatever is the lowest based on the following factors:
- 18% of your income from the previous tax year
- The maximum annual contribution limit for the current tax year
- Your remaining available limit after contributions made to a company-sponsored pension plan
To find out your personal contribution amount, check your notice of assessment for your most recently filed taxes from Canada Revenue Agency.
What happens if I exceed my RRSP contribution limit?
If you or your employer over contribute to your RRSP or pension plan, you will be hit with a tax of 1% on the amount in excess for each month that you remain over-contributed by $2000 or more. You will need to pay this tax within 90 days following the end of the calendar year to avoid accruing interest or filing penalties. You can resolve this issue and prevent further taxation by withdrawing the excess contribution amounts or if you have contributed to a qualified group plan.
Can you withdraw from your RRSP?
Yes, you can withdraw funds from your RRSP at any time, for any reason, even before your retirement. Should you make a withdrawal, you will need to report it when you file your taxes for the year as it now counts towards your income.
What happens to your RRSP when you reach 71 years of age?
Once you have reached 71 years of age, you must close your RRSP account. You may withdraw your investments and funds in cash, convert your account into a Registered Retirement Income Fund (RRIF), or purchase an annuity with the funds held in the account. You may also make a partial cash withdrawal and still choose to convert your account into an RRIF or annuity. Each of these options have their own benefits and potential drawbacks which we will explore.
Withdrawing your RRSP in cash
Withdrawing money from your RRSP as cash is very much the same as making a regular withdrawal from any account you may hold, with the exception that the money taken from the account must be reported as income on your next income tax filing, and you will have to pay taxes on the amount.
Converting your RRSP into a Registered Retirement Income Fund
If you decide to convert your RRSP into an RRIF, you’ll want to consider your needs going forward and do some research to select the right institutional provider for you. In addition, you will have your choice between a fully managed RRIF and a self-directed RRIF. As the names imply, you control the investments with a self-directed RRIf, while a fully managed RRIF will mean that your money and investments are handled by an experienced professional.
Purchasing an Annuity
Annuities are financial products that will provide you with a guaranteed regular income payment, either for a predetermined time period or for the remainder of your life. You can purchase annuities on a payment plan or with a lump sum through financial service providers, though they are most commonly provided through life insurance providers.
The payment amounts you receive will be decided based on a number of factors including your age, health, gender, financial contribution, annuity type, and service provider.
When deciding to purchase an annuity you will have a few options to choose from:
A life annuity is a type of annuity that provides you with a guaranteed inflow of income for as long as you live, even after you have received the full amount that you purchased the annuity for.
A term certain annuity in an annuity that will provide you with a guaranteed income for a predetermined time period. Should you pass away before the annuity has paid out the full term, the payments will continue until the full amount is paid to your named beneficiary or estate.
A variable annuity is a unique type of annuity in which your service provider uses the money you used to purchase your annuity to make investments with variable returns. In this option you will receive a smaller fixed income in addition to your variable income payments, so your income is tied to the performance of the investments made on your behalf.
Our top 3 recommendations for your RRSP
Wealthsimple is a great place to open or transfer an existing RRSP account. Their accounts have no opening minimum and are low fee, only charging 0.5% on their free Wealthsimple Basic account and 0.4% on their paid Wealthsimple Black accounts, with no costs for trading, account transfers, and rebalancing.
In addition, Welathsimple provides an automatic contribution tracking tool to simplify the process of managing and investing in your RRSP. Wealthsimple users have access to financial and investment advice from top financial experts at any time, as well as their cutting edge Nobel prize-winning portfolio building strategies and technology to ensure that your portfolio is optimized to make the most of your money.
Tangerine is also a wonderful provider to consider when looking to open your RRSP, they offer a high-interest rate of 1.15% on their RRSP, with an introductory interest rate of 2.75% on any contributions made within the first six months, and 1.15%. Like Wealthsimple, Tangerine has no minimum account balances and no annual fees. Pre-existing customers of the bank can join their Automatic Savings Program to set and forget their investments and can transfer money from their RRSP into other investment accounts or RRSPs at any time without any additional cost.
Questrade is our final recommendation for your RRSP. They are the fastest-growing broker in Canada, and offer accounts with no minimum balance, no fees to open, close, or transfer your account. Accounts with Questrade can be managed entirely online, whether you choose to go with their managed Questwealth RRSP or a self-directed one.
No matter who you choose, you can’t go wrong with any of these great providers, and with your new understanding of RRSPs, you are well on your way to starting. growing, and managing a healthy investment account to help you live comfortably in retirement.
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