Registered Retirement Savings Plan
What is a RRSP?
A RRSP is a government registered account that allows individuals to set money aside for retirement and get a bit of a tax break on their current income. Contributions are tax-deductible. This means contributions reduce an individual's taxable income. What does this look like? Well it depends on how much income you earn, but take a look at the example below:
Let's say you make $60,000 annually, and you contribute $5,000 to your RRSP. That year you will be taxed $60,000 - $5,000 = $55,000. This sounds almost too good to be true. Well, there is a catch: Like a TFSA, any money that grows within your RRSP will not be taxed. Unlike a TFSA, however, you will be taxed when you withdraw from your RRSP (except for in two scenarios which we will discuss later on). The reason for this is that the money in your RRSP has not been taxed yet.
Well, what is the point of not taxing the money in the first place if you are going to tax it later? There is a benefit, I promise. The main purpose of your RRSP is to save for retirement. Since you are not working in your retirement years, you will be in a lower tax bracket. This means that when you do withdraw from your RRSP come retirement time you won't be taxed as highly as you would have been had you not contributed at all. To successfully take advantage of your RRSP; contribute when you are in a higher tax bracket, and withdraw when you are in a lower tax bracket.
Tax Rates on Withdrawals
The rate at which you are taxed depends on the amount you withdraw :
10% (5% in Quebec) on amounts up to $5,000
20% (10% in Quebec) on amounts over $5,000 up to including $15,000
30% (15% in Quebec) on amounts over $15,000
Like a TFSA, there are penalties if you surpass your contribution room. As with your TFSA, the best way to know your specific RRSP contribution room is to contact CRA. However, for those who like to know how things work, we will give a broad overview of how contribution room is calculated :
Again, like a TFSA, contribution room is accumulated, and each year the government announces the annual limit.
Contribution room = unused contribution limits + the lesser of either the annual limit OR 18% of previous year earned income.
Penalties for Overcontributing
Overcontribution to your RRSP carries the same penalty as overcontributing to your TFSA: 1% of the overcontribution amount per month that it remains in the plan.
Home Buyer's Plan (HBP)
As mentioned earlier, there are two scenarios where you can withdraw from your RRSP tax-free. The first one we're going to look at is the first-time home buyer program. This allows you to withdraw up to $35,000 from your RRSP tax-free to put towards a down payment on a home. To be eligible, you need to a first-time home buyer. You are considered a first-time home buyer if you have not occupied a home you or your spouse owns in the last four year period.
You are required to pay back the withdrawn amount to your RRSP over a 15-year period. Basically, you are paying yourself back. If you miss a payment in a given year, the amount will be added to your income and you will be taxed accordingly.
Lifelong Learning Program (LLP)
The second scenario where you can withdraw from your RRSP tax-free is known as the Lifelong Learning Program. This program allows you to withdraw from your RRSP tax-free to fund full-time training or education for you, your spouse, or your common-law partner. You are allowed to withdraw a total of $10,000 per calendar year up to a total of $20,000.
As with the HBP withdrawal, you are required to pay back the withdrawn amount to your RRSP. With the LLP, you have 10 years to pay it back.