2024 RRSP (Registered Retirement Savings Plan) Best-explained

 

In the last posting we talked about TFSA

What is a RRSP?

Registered Retirement Savings Plan is a form of investment account that 'defers' taxes on earned income for each year 'AND' investment returns within this account.

RRSP is a form of financial benefit provided by Canadian government to foster retirement savings for Canadian residents.

 

Types of accounts

There are many types of accounts in Canada: 1. chequing account 2. savings account 3. tax free savings account 4. registered retirement savings plan 5. registered education savings plan 6. non-registered investment account 7. registered disability savings plan 8. locked in retirement account

Chequing account can only hold cash whereas RRSP can hold various types of assets: cash, mutual fund, stock, ETF, and others.

 

Understanding Canada's tax filing system

There are other types of benefits/accounts, and in order to understand how they work, we must understand Canada's tax filing system. (Quite easy to understand)

In Canada, if you make any form of income, you are expected to file it to Canada Revenue Agency(CRA), then pay taxes on the filed income. and the tax you pay is called an income tax.

Tax filing can get sophisticated for many people and filing such complex income taxes can cost you $$$. But don't worry, you can save $ to file through professional tax filing platforms such as Turbo tax. Canada's #1 online tax filing platform.

 

RRSP Example

Jane is employed at a logistics company and got paid $80,000 salary last year. Jane has carried over RRSP contribution limit of $30,000 from previous years.

(RRSP contribution limit: the lesser of 18% of your income from the previous year or the annual limit set by the CRA up to a maximum of $30,780 for tax year 2023)

Jane has $60,000 investment in RRSP which made $6,000 interest income last year and $40,000 in a regular investment account(officially called Non-registered account)  which made $4,000 in interest income last year.

Jane makes $10,000 RRSP contribution to claim tax refund.

Therefore, Jane is required to file and pay income taxes on the following amount:

  $80,000 salary income

+$4,000 interest income(non-reg)

- $10,000 RRSP contribution

=$74,000 taxable income. 

If Jane's tax rate is 30%, she will owe to CRA $74,000 * 30% = $22,200. Since returns made from RRSP is *tax deferred* and $10,000 new contribution is *tax deductible* John saves 30% of $10,000 = $3,000 in taxes. 

 

RRSP Withdrawals

Now, unlike TFSA where withdrawals are free of taxes and doesn't have much limitations, RRSP withdrawals can come with tax consequences unless it is being withdrawn under permitted special causes under CRA rules.

Basic rule

When you put your money into RRSP account = amount of money you put in gets deducted from your income taxes for that year.

When you take your money out of RRSP account = amount of withdrawal gets added to your income for that year.

What's the benefit?

Once you retire, your annual passive income will be much lesser than when you work full time to make active income. (For most Canadians)

For example, if you make $80,000 when you are 35 years old and given that you pay 30% income taxes, making RRSP contribution will save you 30%. Since this tax is *deferred* along with the investment income, by the time you withdraw this contribution plus additional income during retirement, you might only pay 15% taxes on the withdrawal because you no longer have active employment income.

 

Tax free withdrawals 

There are 2 types of permitted special causes for tax free withdrawal from RRSP account.

Home Buyers' Plan

HBP allows you to make tax free withdrawal when you are buying your first home in Canada. Here are eligibility rules.

1. Your contribution must have stayed in RRSP account for minimum 89 days before making the withdrawal (If you make contribution and withdraw 88 days or less later, you are not eligible for HBP and you will have to pay withholding tax on the withdrawal)
2. If you owned a home that had your name on title in the past 5 years, you are not eligible
3. This is not a completely tax free withdrawal because you must re-contribute / put the withdrawal back into RRSP account within and over the next 15 year. So, essentially you are borrowing $ from your own RRSP account. (If you fail to re-contribute, amount you owe yourself each year becomes taxable income

Lifelong Learning Plan

1. LLP allows you to withdraw up to $10,000 in a calendar year from your RRSPs to finance full-time training or education for you, your married spouse or common law partner.
2. Similar to HBP rule, you must repay the used withdrawal within and over the next 10 years.

Frequently Asked Questions

1. Is TFSA better or RRSP? 

You can own all of these accounts, however if you need to choose an account to start with, this question depends on a few factors: your annual income (Is it over $100,000?); your future plan to make the first home purchase; future plan to pursue further education?

If you answer yes to at least 2 of the above, it might be better to start with RRSP first, but don't be so quick about your decision. Make sure to know what you are saving for, and know what account types are there for you before pulling the trigger.

2. What investments can I hold inside RRSP?

You can hold stocks, mutual funds, GICs, ETFs, and other investment types approved by CRA.

3. What is my RRSP contribution limit? 

RRSP contribution limit is the lesser of 18% of your income from the previous year or the annual limit set by the CRA up to a maximum of $30,780 for tax year 2023. If your income from the previous year was $100,000, your RRSP contribution limit will be $18,000.

If you income from the previous year was $300,000, your contribution limit is capped at $30,780 for the year.

For full details of RRSP, you may visit the link below:

Official CRA website

 

Other types of accounts

TFSA

RESP

FHSA

RDSP

 

Which platform should I use to open RRSP?

I have used multiple trading platforms, and I find Questrade has the cheapest trading cost that can save you $$.