Your Comprehensive Guide to RRSP - Registered Retirement Savings Plan

The Registered Retirement Savings Plan was first introduced in 1957 as an incentive for Canadians to save for retirement. More than 60 years later, RRSPs continue to be the savings vehicle of choice for Canadians, with nearly one-quarter of tax filers contributing each year.

This comprehensive guide to RRSPs will explain what they are, why make an RRSP contribution, and how to open one. Plus, you’ll learn what your annual RRSP contribution limits are, the tax advantages and disadvantages, and how RRSPs compare to other savings plans.

What is an RRSP and how does it work?

An RRSP is a registered retirement savings plan and a tax-deferred account. If you contribute to an RRSP you’ll receive a tax deduction, which reduces your overall net income. Investments grow inside an RRSP in a tax-deferred manner, which means you won’t be taxed on them until you withdraw funds. Down the line, any withdrawals you make from an RRSP are taxed as income.

Tax filers create RRSP contribution room when they earn income (employment, self-employment, and net rental income are the most common). Unused contribution room can be carried forward indefinitely to future years.

You can contribute to your RRSP during the first 60 days of the year and still receive a tax deduction for the previous year’s taxes. This is called the RRSP deadline.

Your RRSP can remain open until age 71, at which time it must be converted into a Registered Retirement Income Fund (RRIF) where it faces minimum mandatory withdrawal rules.

Ideally, Canadians would contribute to their RRSPs in their high-income earning years and withdraw from their RRIFs in lower-income years (i.e., retirement). That’s because the tax deduction you receive for contributing at a high income will be greater than the tax payable when you withdraw at a lower income.

How to set up an RRSP

Canadians can open an RRSP account at any bank or credit union, with a robo advisor, or through an online brokerage.

Once your RRSP account has been opened you can make a one-time contribution, set up automatic recurring contributions, or even transfer an existing RRSP over to consolidate your retirement savings accounts into one.

You can have more than one RRSP account if you stay within your available RRSP contribution limit.

RRSP contribution and deduction limit

Anyone who has earned income and filed a tax return will have accumulated RRSP contribution room. Your contribution room is 18% of your previous year’s income, to a maximum of $30,780 (in 2023), plus any carry-forward contribution room that you may have.

Contributions made during the first 60 days of the new year can still qualify for a tax deduction for the previous year (or they can be used in the current year). You do not have to claim an RRSP contribution in the year you made it – you can carry it forward to a future year and claim the deduction then. This could make sense if you expect to be in a higher tax bracket in the future.

You’ll receive your official RRSP deduction limit on your Notice of Assessment, but Canadians can also log into their MY CRA Account to check their limit.

Note that if you participate in a pension plan your RRSP deduction limit will be reduced by something called the Pension Adjustment (PA).

The RRSP deduction limit is calculated as follows:

Step 1: Calculate unused deduction limit at the end of the previous year

• Previous year’s RRSP deduction limit
• Minus: Allowable RRSP contributions deducted in previous year
• Minus: Employer contributions to PRPP in previous year
• Equals: Unused RRSP deduction limit at the end of previous year

Step 2: Calculate additional deduction limit based on previous year

• 18% of previous year's earned income up to $29,210 (whichever is lower).
• Minus: previous year’s pension adjustment
• Equals: Additional deduction limit based on previous year

Step 3: Calculation of current year’s RRSP deduction limit

• Unused RRSP deduction limit at the end of previous year
• Plus: Additional deduction limit based on previous year
• Equals: Current year’s RRSP deduction limit

RRSP over-contribution

There’s some margin of safety built into your RRSP contribution limit. The federal government allows for a lifetime $2,000 over-contribution limit to your RRSP.

Contributions made over and above your RRSP deduction limit (but within the $2,000 over-contribution limit) will not receive a tax deduction.

A 1% penalty tax per month will apply to RRSP contributions that exceed the $2,000 over-contribution threshold.

What investments can you hold inside your RRSP?

It’s important to know that Canadians don’t just “buy RRSPs.” An RRSP is a tax-deferred account, and inside it, you can invest in just about anything: from stocks, mutual funds, and ETFs to bonds, GICs, and money market funds or cash. You can even hold your mortgage inside your RRSP.

Contributing to your RRSP is a two-step process:

1. Make the contribution by transferring an amount from your bank account to your RRSP. That amount sits in cash inside your RRSP, waiting to be deployed into your investment of choice.
2. Purchase the investment. If you’re just learning to invest, you can do this by using a reputable robo advisor. Our number one choice is Wealthsimple.

If you’re a seasoned DIY investor, cut trading fees to the bone and use a top-rated online brokerage like Questrade. Also, Wealthsimple Trade offers zero-commission trading — meaning you can buy and sell stocks and ETFs for free.

Registered Retirement Savings Plan benefits

There are four main benefits of RRSPs.

• The first is obvious – a tax deduction. RRSP contributions can reduce your taxable income and lower the income tax you pay.
• The second benefit is tax deferral. Your investments grow in a tax-deferred manner inside your RRSP. You don’t pay tax until you withdraw funds.
• The third advantage is income splitting. A high-earning spouse can contribute to their partner’s RRSP by setting up a spousal RRSP. The contributing spouse gets the tax deduction while the non-contributing spouse builds up their RRSP balance.
• The fourth advantage is access to federal government programs such as the Home Buyers’ Plan, which allows first-time homebuyers to withdraw up to $35,000 from their RRSP to use for a down payment on their home, and the Lifelong Learning Plan, which allows them to withdraw up to $10,000 per year ($20,000 maximum) for qualified education expenses.

Tax implications from withdrawing funds from an RRSP

Canadians must convert their RRSP to an RRIF in the year they turn 71 and begin withdrawals the following calendar year. But you can also withdraw directly from your RRSP at any time and for any reason.

Doing so will have tax implications. RRSP withdrawals must be added to your income when you file your taxes. More importantly, withdrawals are also subject to withholding tax – meaning your financial institution will withhold a percentage of your withdrawal for tax purposes.

• Withdraw up to $5,000 = 10% withholding tax
• Withdraw between $5,001 and $15,000 = 20% withholding tax
• Withdraw more than $15,000 = $30% withholding tax

Know that by withdrawing from your RRSP early you will miss out on tax-deferred compounding inside your retirement account. You also lose your contribution room forever.

FAQs

Can you lose money in an RRSP?

Yes. An RRSP is simply a tax-deferred savings account. It’s what you invest inside this account that matters. Stocks, mutual funds, ETFs, and even bonds can lose money over certain periods. Risk and reward are joined at the hip. If you’re looking for ultra-safe investments for your RRSP then stick to GICs and money market investments.

Is it better to put money in a TFSA or RRSP?

The RRSP and TFSA are mirror images of each other. Contributions to an RRSP receive a tax deduction, but withdrawals are taxed as income. Contributions to a TFSA do not receive a tax deduction, but withdrawals are tax free. Your marginal tax rate drives this decision. If you’re in a higher tax bracket now than you expect to be in retirement, prioritize your RRSP. If you’re in a lower tax bracket now than you expect to be in retirement, prioritize your TFSA. If you expect your tax rate to be the same, then it makes no difference which account you prioritize – the results will be the same.

What is the RRSP limit for 2023?

The maximum RRSP contribution is 18% of your gross income or $30,780, whichever is lower.

How much do RRSPs lower your taxes?

A contribution to your RRSP will reduce your taxable income by the same amount. For example, an Ontario resident who earns $110,000 and contributes $10,000 to her RRSP will reduce her taxable income to $100,000. This results in tax savings of $4,341. That’s because income between $98,000 and $150,000 in Ontario is taxed at 43.41%. Your tax savings depend on the province you live in and your marginal tax rate.

Can RRSP contributions increase your Canada Child Benefit amount?

Yes, RRSP contributions reduce your net income which is the criteria used by the federal government to determine how much Canada Child Benefit you’ll receive. These benefits are “phased out” at certain income thresholds, so by reducing your net income you may increase your Canada Child Benefit amount.

Final Word

RRSPs are the foundation for any solid financial plan and should be used both as a tax-saving tool now and as a source of retirement savings for the future.

The key is to contribute to your RRSP during your high-income earning years to maximize your tax savings, and then withdraw from it in retirement when you’re hopefully taxed at a lower rate.

Finally, don’t just “buy RRSPs,” but contribute to an investing account and then purchase the appropriate investments inside to maximize your tax-deferred growth.

Debating whether to invest using a TFSA or RRSP? Read our comprehensive article about TFSA or RRSP and how to choose between the two.