Registered Retirement Savings Plan

It's never too early to plan for retirement. Read on to learn more about a Registered Retirement Savings Plan (RRSP).

*I am not a financial adviser, please consult a financial expert when making financial decisions. This blog is based on my personal experiences and not to be used as financial advice.

What is an RRSP?

A Registered Retirement Savings Plan (RRSP) is a registered tax-deferral account that has been available since 1957. The Canadian Government implemented it to help Canadians save for retirement.

How do I set up an RRSP?

You can open a registered account with your financial institution, trust, insurance company, credit union, online brokerage firm, or wealth management firm.

There is no age of maturity to open an RRSP, and you can contribute to an RRSP until December 31st of the year you turn 71.

You can also contribute to your spouse or common-law's RRSP. For more information, visit the CRA website.

What are the Benefits?

Contributions to an RRSP are deducted from your annual taxable income, giving you a "tax advantage," and you will likely receive a tax refund.

For example, suppose I make a salary of $60,000 and contribute $5,000 to an RRSP. That $5,000 will be deducted from my taxable income.

$60,000 - $5,000 = $55,000

During the annual filing of my taxes, my taxable income is now considered $55,000 and not $60,000.

Because I would have paid taxes throughout the year based on an income of $60,000, I will likely receive a tax return, given my taxable income is now $55,000.

As I grow my RRSP by making yearly contributions, I also earn investment income inside my RRSP. Earnings can come from dividends, interest, and capital gains from eligible investments.

You can self-manage your RRSP investments or have someone manage them for you. I choose to self-manage my RRSP through an online brokerage, Questrade. I will talk more about my experience using Questrade in a future post :)

Speak to your financial adviser to learn more about investing through an RRSP and determine what is right for you.

RRSP Contributions

There is a formula to calculate your contribution limit and an annual cap set by the Government. Your annual contribution limit is the lesser of these values plus any previous amounts carried forward.

According to the Canada Revenue Agency website, the annual deduction limit in 2021 is $27,830.

Your annual contribution amount is, therefore, the lesser of;

• 18% of your earned income of the previous year

• the annual RRSP contribution limit ($27,830 in 2021)

Visit https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/rrsps-related-plans/contributing-a-rrsp-prpp/contributions-affect-your-rrsp-prpp-deduction-limit.html for more information :)

Assuming I made $60,000 in 2020, the calculation for my RRSP contribution room is as follows;

$60,000(0.18) = $10,800 or $27,830 (2021 limit)

Since $10,800 < $27,830 my maximum contribution in 2021 is the lesser of the two @ $10,800.

Unused Contributions

Every year you build a contribution room equal to the lesser amount of the formula described above. This amount carries forward every year.

For example, assume I made $58,000 in 2019, and $27,230 was the 2020 contribution limit. I had made no contributions to an RRSP that year.

This amount is carried forward indefinitely.

$58,000(0.18) = $10,440 (this is the lesser value)

My contribution amount in 2021 would therefore be:

$60,000 (0.18) + $10,440 (unused contributions) = $21,240

The examples I am using are relatively simple. Suppose you have or had a pension through an employer. In that case, this impacts your contribution room, and there are other stipulations.

To determine what you have available for an RRSP, consult with your financial adviser.

RRSP is a registered "tax-deferred" account

Any investment income earned inside an RRSP is also tax-deferred; it is not considered income until you withdraw from your RRSP.

When you withdraw money from your RRSP, this amount will increase your taxable income for that year.

So back to the example above, consider I make $60,000 in taxable income, and I take out 5,000 from my RRSP the same year.

I now have a taxable income of $65,000. Come tax time; I will have to pay taxes on the additional $$5,000 ouch.

Why would someone then consider investing in an RRSP?

The idea is in the title Registered "Retirement" savings plan.

I may not have a pension plan through my employer, maybe I am a seasonal worker, self-employed or other, and I want to create my retirement plan. Or perhaps I do invest in a company pension, but I don't plan to work there until retirement.

The list of reasons can go on.

When you enter into retirement, generally, you are no longer working. Therefore, the amount you withdraw from your RRSP is now your sole income.

After budgeting your expenses, you may decide to need $60,000/year to live.

Since you have no other taxable income, you begin drawing down from your RRSP, and the annual amount you take out is now the income you are taxed on.

If you plan carefully, you can withdraw an annual income at a lower tax bracket, reducing the amount you pay in taxes.

And there is another gift from the Canadian Government that can help you do that.

TFSA and RRSP working together

I am determined to pay the least taxes in my retirement, but I want to travel too. These things cost money!

I live in Newfoundland, so let's say I withdraw an annual salary of $38,000 from my RRSP in retirement, but $60,000/year is what I need to meet my retirement dreams.

In 2021 $38,000 is in a tax bracket of 8.7 %, according to https://turbotax.intuit.ca/tips/newfoundland-and-labrador-provincial-taxes-and-credits-569

If I take out $60,000, the additional $21,919 will be in the 14.5% tax bracket.

Here's the math: $60,000 - $38,081 (turbo tax link above) = $21,919

I can supplement my annual RRSP withdrawal by withdrawing from my TFSA.

see my post on a TFSA here: https://www.bogitsblog.com/post/the-tax-free-savings-account

Based on my annual retirement salary of $38,000, I need $22,000 to obtain my goal of $60,000.

And any amount is withdrawn from my TFSA; it is not considered taxable income :)

So, my annual taxable income in retirement will still be $38,000.

Neat hey?