A Registered Retirement Savings Plan is the most popular retirement savings scheme amongst Canadians. Not only does it reduce your income tax but also grows tax-free until the time you withdraw your contributions. So unlike a TFSA account, your savings grow while being tax-deferred rather than tax-free.
Do I really need an RRSP?
Not at all, you could also choose a TFSA (Tax-Free Savings Account) or other investment scheme. But even when I’m advising those in their early to mid-twenties who are getting a regular paycheck I really reinforce the importance of putting money away for retirement. We are living longer thanks to modern medicine, but our working life has only extended a few years. We have to work harder in our career to secure a comfortable pension.
Each individual is given a maximum amount to which they can contribute to their RRSP. The reason for this is due to the initial tax deduction benefits that one enjoys through this scheme. To find this sum, simply look at your most recent Notice of Assessment from the Canada Revenue Company.
Here are the basics you need to know about your contribution room:
- The annual deadline for this is 60 days into the following taxation year.
- You can also carry forward contribution room from previous years.
- There is a $2,000 leeway before you enter into over-compensation however, this figure is not tax deductible.
When can I apply for an RRSP and for how long?
You can begin investing in your RRSP once you reach your second year in employment. It is best to start as early as possible as even small injections made in your twenties will experience considerable growth by the time you retire. This is thanks to compound interest and you can start with as little as $50 a month.
As for the second part of this question, the simple answer is the 31st December on the year which you turn 71. You may be interested in setting up a spousal RRSP in addition to your individual one if your spouse is younger than you. This way you can continue placing contributions into this plan until the year end that your partner reaches his/her 71st birthday.
Penalties for over-compensation
For each month that the excess exists you will be charged 1%. There are two options available to you if this happens; either report and pay the tax or sign a waiver. For the first option, you need to fill out the T1-OVP form which is the Individual Tax Return for RRSP Excess Contributions. A waiver is more suited to those who have made an honest error in their tax calculations, and this can often be ironed out by providing documentation proving your mistake and, of course, removing your excess.
Self-directed RRSPs require quite a bit of know-how and management to get the most out of them. There are a few points I’d like to share to make sure that you are ready to open such an account. First off, they are set up in an investment or brokerage firm. Typically, investment firms provide advice on how to set up your plan, but in exchange, you will be charged higher rates than in a brokerage.
In your RRSP you can make multiple investments. There’s a whole lot of fees that can really add up from annual fees to trustee fees and also investment management charges. Similar to your choice of going to a brokerage or an investment firm there’s a range of support and services that will save you time and lend you expert advice. However, the costs can be steep. If you’re knowledgeable and even enjoy investing and keeping track of these investments, then you’re likely to save regarding fees.
Another option is to have a Spousal plan. The significant benefit of this opportunity is to create space in your contribution room. It works best for couples who are in different tax brackets. The higher earn spouse can benefit from the lower tax bracket of their other half.
However, there are many examples of family-income splitting that you should look into before simply taking this relatively simple and most popular route such as prescribed loans.
There are many implications for choosing to withdraw a sum from your RRSP before retirement. It depends on whether or not you reside in Quebec and the amount you take out but the tax, known as withholding tax, is 5-30%. Without a doubt, this money is usually only taken out in emergency situations. Unfortunately, you’ll also permanently lose the contribution room you used to make those contributions. Your withdrawal is also taxed as regular income. This is yet another reason why you should avoid withdrawing your contributions prematurely.
That being said, there are times when you can dip into your RRSP without steep costs for doing so. These are buying your first home or deciding to invest in your education. I don’t have room to discuss these exceptions in-depth in this blog post, but I plan to explain the particulars in a later article.
Our Top Tip
It can be hard to put away money. There are so many demands on our income from rent or mortgages to utilities and childcare that it can be difficult to set up an RRSP. It is hard to see the benefit of something that will benefit you way out in the distance. What about the motto “to live in the moment?” You would, of course, prefer to use your disposable income right now for festival tickets, help with buying a new, shiny car or a shopping spree.
And look, I’m not going to scold you like a child or undermine you by emphasizing how important it is to look after yourself financially. Many are understandably reluctant to part with any of their money or worried about a decrease in their standard of living.
What I do suggest is if you haven’t yet set up an RRSP then work towards a pay increase. Once you get your income boost, set up an RRSP and pump the pay rise into the scheme. This is a much more pain-free method of getting your pension in order; as they say out of sight, out of mind.