A Beginner Guide About What is An RRSP and When You Need to Start One

Posted on October 25, 2018

A sizable percentage of the working class are entering retirement soon, but are they ready for it?

The good news is that the majority of Canada's workforce has retirement savings. The sad news is that about 32% of those who are retiring soon still have no savings.

The reasons could be anything, but one thing is for sure. Most, if not all, didn't set up a good retirement plan when they were younger.

If you don't want to end up being like one of the 32%, you must act now. Check out the different plans available for you, like an RRSP.

What is an RRSP, anyway? Find out what it is, how it can benefit you today, and why it's helpful in your retirement age.

What is an RRSP

A Registered Retirement Savings Plan (RRSP), as the name indicates, is a retirement savings and investment vehicle for the employed and self-employed. Contributors provide a part of their own money, which grows until they withdraw it.

The money in the account can buy investments, including mutual funds, stocks, GICs, and more. When the user withdraws the money from the account, the government sees it as an income and so charges tax for it. The contributor can withdraw at any age, and the amount will be a taxable income for the year of the withdrawal.

It has a similar structure to other retirement plans all over the world, such as the 401(k) in the United States. However, it has some key differences as well.

For example, an RRSP doesn't impose early withdrawal penalties. The unused contribution limits can carry over to the following year. RRSP also has a set contribution amount limit: 18% of the professional's salary the previous year or a maximum of $26,230.

The limit can increase if a person has unused contribution limits from the previous year. He/she can also contribute beyond the limit, but there will be penalties.

You shouldn't confuse it with Registered Pension Plans (RPP) as well. While RRSPs are individual plans, RPPs are plans from a company or a union. Both plans offer the same benefits, but the contributions to the latter come from the gross wages.

Types of RRSP

Today, there are 3 basic types of RRSP: individual, spousal, and group. Here's a look at how each one works:

Individual RRSP

This is an account in your name, with you as the one who set it up and the contributor. All the money and investments in the RRSP all belong to you.

You may build your own RRSP investment portfolio as you wish with self-directed RRSPs. As an alternative, you may also speak to an advisor.

Spousal RRSP

This one is an account that your spouse or common-law partner holds. The investments belong to your spouse (the account holder), but you may also contribute to it.

You get the tax benefits of the money you contributed. Your contribution also takes away a part of your annual contribution limit. It doesn't affect your spouse's limit, though.

Upon retirement, you and your spouse get an equal share of the retirement income. This can result in a lower tax than if you each contributed to an individual RRSP. This is a good move if you have a higher income than your spouse.

A spousal RRSP account has a set of requirements for both you and your spouse, though:

  • you must have been living together for 12 months or more;
  • you have a child through birth or adoption; or
  • you share custody of a partner's child/ren from a previous relationship

The set of rules also cover the instances wherein a couple splits. If they're married, they'll get an equal share of the assets. If they're common-law partners, they may divide the assets as they please provided that they a joint agreement.

Group RRSP

A group RRSP is one that an employer sets up, usually paying for the costs of opening the account. It's not that different to an individual RRSP, except you contribute via your employer. The contributions usually come from the pay deductions.

Group RRSPs have different rules and options. you'll have to talk with your employer to understand your particular group RRSP.

Why You Should Open an RRSP Account

We know that it helps us save for retirement, but why is an RRSP more beneficial than saving ourselves? Is it worth getting one on top of a pension plan? Is it worth all the hassle?

Well, aside from the fact investing is always a good idea, check out the following reasons why you should get an account now.

RRSP Offers a Lot of Tax Benefits

First of all, the contributions you make to your RRSP account are tax-deductible. Your savings are greater if you're in the higher tax bracket. To take advantage of that, you may "postpone" the tax deduction on the current year's RRSP's contribution to another year when you're in a higher tax bracket.

Of course, if you do this step, you'll have to make sure your future income will allow you to move the next bracket. Otherwise, you'll save less on tax deductions if you end up in a lower bracket.

Another one of the RRSP tax benefits is that the money you earn through investments is not taxable as long as it stays in the account. This includes money you earn in the form of dividends, interest, or capital gains.

You'll have to pay tax on your income at some point, though. That is when you withdraw the money, and because the tax tends to be lower in retirement, you would pay less tax by then.

You Can Convert an RRSP to an RRIF or Annuity

By the year that you turn 71 years old, the rules state that you liquidate your RRSP account. This means you'll have to pay the tax for the full amount. If that's not the right solution for you, consider converting it to a Registered Retirement Income Fund (RRIF) or to an annuity.

The advantage of these is that you only pay tax for the payment you received for each year. An RRIF has a minimum required withdrawal amount, though, and it depends on your age. In an annuity, on the other hand, your income depends on the features of your plan.

Choosing either one can mean that you have a guaranteed income for life. Each one has its own pros and cons, so you'll have to take a careful look to see which one will work better for you.

You Can Borrow from Your Account Tax-Free

Want to buy a home or fund your education? Not to worry; you may borrow from your RRSP account.

Through the Home Buyers' Plan (HBP), you'll be able to borrow up to $25,000 for the down payment of your home. However, you must be a first-time home buyer to avail this plan.

If you also want to continue your education, you may borrow up to $20,000 to fund it. Under the Lifelong Learning Plan (LLP), however, you enroll as a full-time student in a qualified program at a designated educational institution.

Withdrawals under these plans are tax-free as long as you pay back the money within the specified period.

How to Open RRSP Accounts

Have you decided on opening an RRSP? Don't worry, the process is easy; it's even easier if you go for a group RRSP since you'll only have to talk to your employer.

If you're opening an individual or a spousal account, however, follow the steps below.

1. Compare RRSP Plans from Different Institutions

Different plans have different fees, that's why you should shop around first. Contact banks and other financial institutions, then, inquire about their plans and options.

2. Choose How You Want to Invest Your Money

If you want to hold a host of investments, a self-directed RRSP might be the better choice.

Other plans might limit the type of investment you can make. For example, an account from a particular bank may only let you hold mutual funds or GICs.

Shop around first and then decide which one suits your interest and needs best.

3. Choose the RRSP Plan for You

Once you have a list, begin selecting which ones you think are right for you. Note that the right RRSP plan should suit your current needs and retirement goals.

If you've already found the best one for you, prepare 2 pieces of identification and then go to an RRSP establishment to apply. You may have to make a contribution right away to open the account.

At that time, you may also set up a contribution schedule. Ask the financial institution for their options.

What are You Waiting for?

What is an RRSP?

Hopefully, this guide provides the answers you seek and showcase how it can benefit you. Now it's time to take the next step.

Still a bit confused?

To learn more about insurances, feel free to visit our blog today! If you have more questions about this plan, contact us now! Let's discuss if it's right for you and how you can maximize it to your advantage.

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