The RRSP – or Registered Retirement Savings Plan – is a Canadian registered investment account introduced by the Canadian government in 1957 as part of the Income Tax Act, and it was created to help people save for retirement. As long as you’re living in Canada, are earning a Canadian income, you’ve filed at least one tax return, and you’re under 71 years old, you’re eligible to start using an RRSP to invest.
Yes – you saw that right – even though it has the word saving in the title, we’ll be focusing on how you can use this account to invest and set yourself up for the future.
What Is The RRSP?
The RRSP is a tax advantaged account that exists so that people will put money away specifically for retirement – and you’re incentivized to do this because of the tax benefits. In order to take full advantage of those benefits, you’ll want to invest the money you put into this account so that it grows.
But before we get into that, let’s start by making sure we all understand what it means when we say that the RRSP is an investment account. When you go to invest money, you need a place to do it – like a bank or an online platform – and then, you need to choose an investment account that you want to buy the investments in.
Think of it like this – picture a laundry basket, that’s the RRSP itself – you can fill that basket up with clothes – or in this case, stocks, bonds, ETFs, other investments. The RRSP itself is just the carrier.
Benefits Of The RRSP
So, what are the tax benefits for this laundry basket vs another type of laundry basket (aka another investment account)? The RRSP is tax deferred – meaning that for now, any money that you earn on your investments purchased within an RRSP is tax free.
But, notice that I said for now – this is the biggest rule you need to know to understand the RRSP, and it’s about that keyword, retirement. Your money grows tax free until retirement – then, as you hit retirement and start to sell your investments and take the money out to use, you pay taxes on the money then.
What Does ‘Tax-Deferred’ Mean?
Let’s break what tax deferred really means, starting with a quick example.
Let’s say that you made $50,000 per year, and you contributed $9,000 to your RRSP during that tax year. When it’s time to file your taxes, instead of the CRA looking at your income as $50,000 – they would look at it like it was only $41,000 ($50,000 minus $9,000 = $41,000).
The benefit here is that a $41,000 income would mean that you owe less in taxes than a $50,000 income; basically, you were allowed to legally not pay taxes on $9,000 of your income – that’s the advantage with the RRSP.
But that doesn’t explain the deferred part – that explains the benefit you get now. Even though you’re not paying for that $9,000 in taxes now, you will have to eventually – when you withdraw money out of your RRSP for retirement.
That’s still better than paying taxes now, because ideally your income coming in each year when you’re retired is likely going to be lower than your income is today. Example time – let’s say you actually make $100,000 now. Part of your income is being taxed at 15%, part at 20.5%, part at 26% and part at 29% (so when you’re lowering that income down by adding money into your RRSP, you’re getting to skip out on those higher brackets).
Then, when you retire, if you withdraw money from your RRSP – let’s call it $25,000 per year – you’re only in the 15% tax bracket.
To wrap that up and make it clear – you had to pay taxes on that money, but you got taxed at a much lower rate, saving you money overall.
The RRSP Contribution Limit
Now that we understand the tax benefit we’re getting from using an RRSP to invest, why wouldn’t we just use this account to invest for retirement? Well, you can’t, because just like the TFSA, there’s a contribution limit in place stopping you.
The contribution limit for the RRSP involves a little bit more math, because it’s based on your personal income. In general, you can contribute up to 18% of your income reported on last year’s taxes, up to a cap that changes every year.
For example, if you made $50,000/year – 18% of that income is $9,000, so that would be the maximum amount that you could contribute to your RRSP for that year. But, if you made $175,000/year – 18% of that income is $31,500, so that in theory would be the maximum amount that you could contribute to your RRSP for that year… depending on the current year’s cap. Again, the limit changes each year, so in some years you could add that full amount, and in others you’d be cut off before then (for reference, in 2023 the cap was $30,780, but in 2024 the cap is $32,490).
To wrap up that example, if $175,000/year was your income in 2023, you could only contribute a max of $30,780, and if it was your income in 2024, you could contribute the full $31,500 (keep in mind that we’re talking about pre-tax employment income here, so it’s not what you actually take home, it’s what your salary is on paper, pre-tax).
The other thing that’s important to note about the RRSP contribution limit is that it’s cumulative, meaning that it carries over year over year, starting from age 18.
For example, if you’re 26 right now, and haven’t ever contributed to your RRSP, you don’t only have 18% of last year’s income to contribute – you can add 18% of your income for every year since you were 18 years old.
That might sound like a complicated thing to calculate, but luckily you can login to your CRA MyAccount (FYI, everyone has this account – if you’ve never logged in before you still have one ready for you!) and it’ll tell you exactly what your total contribution room is. Note that it’s only calculated one time per year, so it would currently be your total contribution room as of January 1st, 2024.
Withdrawing From Your RRSP
So what happens when you start to actually withdraw from your RRSP in the future? The good news is that there’s no set retirement age that everyone needs to be at to start withdrawing from your RRSP – technically, you can be ‘retired’ any time before 71 years old and start withdrawing from your RRSP at any time – so, how do you know when you should start taking money out?
The answer is you only want to be withdrawing from your RRSP once your income (and in turn your tax bracket) is lower, because that’s exactly why you put money in your RRSP to begin with. That way, you’re deferring your taxes to a time where you can pay less taxes on that lower income.
For example, if you start putting money into your RRSP when your income is $100,000/year – let’s get specific and say you put in $18,000 that year, bringing your taxable income down from $100,000 to $82,000 (lowering the total amount of taxes you’ll have to pay). Then, if you decide to withdraw money from your RRSP when your income is still $100,000 – let’s say you took $18,000 out – your taxable income goes up from $100,000 to $118,000 (meaning you pay even more taxes while taking the money out).
In this example, you didn’t get any real advantage by putting money in your RRSP! Sure, you paid less taxes in the short-term, but you paid that same amount back a few years later. Using your RRSP to its full potential would mean that you withdraw from your RRSP only when your income is lower, and therefore your tax bracket is lower, allowing you to pay less taxes overall during your lifetime.
TLDR? Start withdrawing from your RRSP only when you have a lower income / are in a lower tax bracket. Oh, and consider contributing to your RRSP when your income is higher, instead of early on in your career.
Wait, There’s An Age Maximum?
In case you didn’t catch this earlier, the RRSP does have an age maximum (yes, you read that right!) of 71 years old. If you wait to withdraw from your RRSP until you’re 71, you can either withdraw all of your funds in a lump sum (remember that lump sum would be taxed as if it’s income!) or you can convert the account to an RRIF, which is a Registered Retirement Income Fund.
If you take that approach, once you have the RRIF there are mandatory minimum withdrawals to make each year, or you can choose to withdraw more.
First Time Home Buyers Plan
The last thing that you need to know is that the only time you can withdraw money from your RRSP and not pay taxes on that money (aka the money you withdraw wouldn’t be added to your taxable) is if you’re using the First Time Home Buyers Plan. If you’ve never bought a house before, you can withdraw money from your RRSP and use it towards buying a home. The pro? You can do this without paying any taxes… as long as you put the exact same amount of money that you took out back in your RRSP within 15 years.
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