An Overview of RRSPs

What is a RRSP?

A RRSP is a Registered Retirement Savings Plan. It is a plan created by the Canadian government to encourage saving for one’s retirement as opposed to completely relying on the Canadian Pension Plan (CPP) and/or Old Age Security (OAS) when he/she retires. The RRSP can be a Guaranteed Investment Certificate (GIC), mutual fund, individual stocks or any other applicable investment as defined by the Canada Revenue Agency (CRA).

What are the benefits?

The two main benefits of starting a RRSP are: 1) the tax refunds and 2) tax deferred growth of your investments.

When you declare an investment as registered, you will get a tax slip from the bank or company you have the investment with when tax time comes. When you file your tax return, you deduct the amount invested in your contribution to the registered account that year from your income; effectively deferring your tax on that amount and getting a larger tax refund.

While your investments are registered in your plan, they will grow tax free. If you refer to my last article on the Tax Effect of Savings, you will realize that the government takes a lot of money from our savings. If they are registered, they cannot tax it until later on, thus allowing the compounding effect to occur at its fullest.

Can’t I just put all my money in a registered plan to protect it from tax then?

No. There is an annual limit to how much you can put into your registered plan and it is generally 18% of your income up to a maximum. The maximum for 2007 is $19,000 and increases every year as per the CRA guidelines. If you go over the amount you’re allowed to contribute, you will get taxed on the excess amount.

When you decide to use this money, the government will tax however much you take out based on the marginal tax rate you have that year. So, even if you can put all your money into a registered savings plan, you still pay tax when you take it out to use.

What’s the point if I still get taxed later?

When you have tax deferred growth, your money grows a lot faster. Even if you tax it later when you take it out of the plan, you will still end up ahead of a non-registered plan.

The second reason is that the purpose of a RRSP is for retirement income. Generally, during your working life your income is higher, resulting in more tax. When you retire, your income should be lower, so when you take out money from your plan, you pay less tax. The tax refund you get back from putting money into a RRSP during your working life should be more than the tax you pay when you take it out to use at retirement.

Another reason is that the RRSP has some options such as the Lifelong Learning Plan (LLP) and first time Home Buyer’s Plan (HBP) that many people can take advantage of. I will go into more detail of these two plans in future articles.

Should I start a RRSP?

The short answer to that question is yes. Everyone should have a RRSP plan. Whether or not it is the BEST plan for your situation will depend on a few things. One thing to consider is whether or not you expect an increase in salary in the next few years. If you do, it may be worth while to accumulate some RRSP contribution room for when you get taxed more, thus getting a larger tax refund. Whether or not this offsets the time lost in compounding will have to be calculated on an individual basis. However, as I suggested earlier, you should stil start saving ASAP even if it's not in a registered plan.

If you have any other concerns about RRSPs, please visit the CRA website for more detailed information at the CRA website.