In Canada, a Registered Retirement Savings Plan (RRSP) is a tax-preferred account for holding savings and investment assets. This type of account was introduced in 1957 to encourage Canadian employees and self-employed to save for their own retirement.
The RRSP is regulated by the Income Tax Act. In this act, you will find the rules that govern maximum contributions, contribution timing, which assets that are allowed, and more.
At age 71, you can convert your RRSP to a Registered Retirement Income Fund (RRIF).
Examples of approved asset types
- Savings account
- Guaranteed Investment Certificates (GIC)
- Corporate shares
- Mutual funds
- Labour-sponsored funds
- Income trusts
- Foreign currency
Contributions are tax deductible, within the limits stipulated by law. An individual’s contribution to their RRSP is deductible from total income, which will reduce the amount of tax that must be paid on income for that income year.
Income earned in the RRSP is not taxed. This includes – among other things – interest, dividend payments, capital gains and foreign exchange gains. This tax-deferrement means that instead of having to withdraw money from your RRSP to pay tax, you can let the money remain in your RRSP account where it will hopefully yield even more income.
According to the main rule, withdrawals from the RRSP are to be taxed as income when the money is withdrawn. There are however exceptions to this rule.
RRSP account types
Individual RRSP account
This RRSP account is associated with only one individual. This individual is known as the account holder. The account holder is also the contributor to the account.
Spousal RRSP account
This type of RRSP account is suitable for couples where one spouse earns more money than the other. The higher earner – known as the spousal contributor – can contribute to the account in the name of the lower earning spouse. The lower earning spouse is the account holder.
A spousal RRSP account can be utilized to lower the marginal tax rate.
Group RRSP account
This is an RRSP account where an employer makes it possible for employees to carry out voluntary contributions through regular payroll deductions. It is up to the individual employee to decide the size of the contribution.
The employer will deduct the money and send it to the investment manger for the group account. The contribution will then be placed in the employee’s individual account.
One of the main advantages with a group RRSP account is that the employee will realize the tax-savings immediately because the income tax deducted from the pay-check by the employer is lowered. If the employee was instead doing private contributions after receiving the full paycheck, the employee would have to wait until the end of the tax year to realize the tax-savings.
Contributions and deductions
Contributions to a RRSP account are usually deducted from taxable income in the same tax year, but there are also some possibilities to hold the deduction for future use.
RRSP contributions made within the first 60 days of the tax year are to be reported on the previous year’s return. Such contributions may be used as deduction for the previous tax year.
With Canadas progressive tax system, being able to reduce your tax at the highest marginal rate can be highly beneficial.
The deduction limit for the next year is printed on every Notice of Assessment or Reassessment, as long as the individual is below the age of 71.
The contribution limit is 18% of the previous year’s reported earned income from employment or self-employment, up to a maximum. The maximum is set by the authorities on a year-by-year basis. This is what the cap looked like for the period 2011-2015.
It is legal to contribute more than the deduction limit. However, any amount $2,000 over the deduction limit is subjected to a penalty tax.