What is an RRSP?

A Retirement Savings Plan (RRSP) is a tax-sheltered investment vehicle that provides you with an effective means of saving for retirement. Contributions to an RRSP result in a tax deduction, and the income earned in the plan compounds on a tax-deferred basis. Individuals with RRSP contribution room in Canada may contribute to an RRSP up to the end of the year in which the planholder reaches age 71.
RRSP-eligible investment options include fixed-income securities, equities, mutual funds, private company shares and more. Plus, with the elimination of foreign content limits for registered savings plans in 2005, you are now free to invest anywhere in the world.

Making Contributions to your RRSP

In order to be deductible in the current taxation year, contributions to your Retirement Savings Plan (RRSP) must be made either during the year or up to 60 days after December 31st of the current year. Contributions made in the first 60 days of the following year can either be deducted in the current year, or in a future year.
The two primary benefits of investing in an RRSP are:
Earned Income: Contribution limits to your RSP are in part based upon a percentage of your "earned income" from the previous year. This includes:
  1. Salary or wages from employment. This amount is reduced by deductible employment-related expenses such as union or professional dues
  2. Disability pensions paid under the Canada Pension Plan (CPP) or Quebec Pension Plan (QPP) (you must be a resident of Canada when you receive the payments) and taxable income from a disability plan. Regular CPP and QPP retirement pensions do not qualify as earned income
  3. Net income from a business carried on by a self-employed individual or by an active partner of a partnership
  4. Net rental income from real property
  5. Payments from supplementary unemployment benefit plans (not Employment Insurance)
  6. Taxable alimony or maintenance payments received
  7. Royalties and net research grants
Contribution Limits: The annual RSP contribution limit depends upon two factors: your prior year's earned income and the prior year's deemed pension benefit from your employer pension plan, if applicable.
To calculate your current RSP contribution limit you must follow a two-step calculation:
  1. Determine your overall limit. Calculated as the lesser of:
    1. 18% of your prior year's income
    2. The legislated annual maximum limit
  2. Subtract your prior year's pension adjustment factor (PA), if applicable. Once your overall limit is calculated, this amount must be reduced if you are a member of a pension plan. If you are not a member of a pension plan or a deferred profit sharing plan (DPSP), your overall limit calculated in Step 1 represents your actual limit for the year.

 

Benefits of RRSP Investing

While most individuals recognize the benefits of investing in a Retirement Savings Plan (RRSP), many do not exploit its unique advantages to their fullest potential. There are three primary benefits to investing in an RRSP:

  • Tax Savings
    Contributions to an RRSP are deductible for tax purposes within certain prescribed limits. In the year a contribution is made to an RRSP you can choose to deduct the contribution from your taxable income. This deduction reduces the amount of taxable income and thus the tax payable. The actual tax savings will depend on your marginal tax rate.

  • Tax-Deferred compounding
    The most significant opportunity offered by an RRSP is the tax-deferred compounding of income earned within the plan. The term "tax-deferred " refers to the fact that all income earned within the RRSP accumulates tax free until withdrawn. If you have $10,000 to invest and have the choice of making an RRSP contribution or not making an RRSP contribution, consider the chart below, which shows the difference between investing the money inside and outside an RRSP (tax-deferred versus taxed). Remember, if you invest the money in an RRSP, you will save $4,000 in tax (assuming a 40% tax rate). Therefore, a $10,000 contribution to the RRSP is comparable to a $6,000 investment outside the RRSP, assuming the tax savings are reinvested. To determine the RRSP advantage we have to convert the RRSP value to an after-tax value. To provide this comparison, let’s assume you will withdraw the $21,589 accumulated by the 10th year and pay tax at 40% on this income. In the unlikely event the RRSP is actually collapsed in the 10th year, you would still have $3,364 more by investing in the RRSP. Allowing the money to remain in the RRSP after the 10th year will further enhance the benefit to you.

  • Income Splitting
    Utilizing income-splitting strategies between spouses can provide significant tax savings. One of the most simplistic, yet effective methods of income splitting between spouses is achieved by contributing to a spousal RRSP. The objective of this strategy is to provide both spouses with similar retirement incomes and thus similar income tax rates in retirement.