A Complete Guide to TFSA and RRSP
Everything you need to know about your RRSP
Registered Retirement Savings Plans (RRSP) have become an essential part of saving for retirement in Canada. This is only more true as housing, food, insurance and other prices have steadily increased in recent years. For many Canadians, retirement may seem far off or the mere thought is stressful. So let's break down the basics of your RRSP and take it step by step so you can make informed decisions about your retirement savings.
Your RRSP offers a range of benefits, including tax savings, tax-free growth, and flexible investment options. Employers in Canada may offer RRSP matching up to a certain amount as part of your salary as long as you are a resident. If you recently moved to Canada or are simply getting started saving for retirement, here is everything you need to know about your RRSP.
What is an RRSP and who can open one?
What are the benefits of an RRSP?
How can I contribute and withdraw from an RRSP?
What are common misconceptions about RRSPs?
Check out the FAQs at the bottom of the article to get some quick answers to the most common questions.
What is an RRSP?
RRSP is a tax-advantaged savings account that is regulated by the Canadian government. With an RRSP, Canadian residents can set aside a portion of their income for their retirement savings.
Contributions made to the RRSP account are tax-free.
Investments can grow tax-free, including dividend reinvestments.
Withdraw after age 71 and pay a lower tax rate.
As a registered account, RRSPs come with rules, regulations, and deadlines that you need to know. Let's go through them below.
When are the key dates for RRSP?
The first thing you need to do is write down the important dates related to your RRSP. Take a pen and paper, or write in your calendar the following dates:
Contribution Deadline: The RRSP contribution deadline for 2024 is March 1st, 2025.
The deadline to contribute to your RRSP for a given tax year is typically on March 1st of the following year, or the next business day if March 1st falls on a weekend. This deadline is crucial for those looking to deduct their RRSP contributions against their income on their 2024 tax returns due April 30th, 2025.
End of the Tax Year: The last day of the tax year is December 31st. Income earned from January 1st to December 31st is used to calculate the contribution room for next year.
Tip: You can work with an accountant or financial advisor to ensure that you won't miss your contribution deadline, or overcontribute. Or, pick a day of the year such as January 25th and make your contributions on the same day each year.
Who can open an RRSP?
The Registered Retirement Savings Plan (RRSP) is one of the easiest accounts to open and usually available at most brokerages across Canada. In fact, you can open multiple RRSP accounts to spread out your accounts across different brokerages. All you need to open an RRSP is the following:
Be a Canadian resident (Citizen, Permanent Resident, or Temporary Foreign Worker)
Have a Social Insurance Number (SIN)
Earn income in Canada and file a yearly tax return with the Canada Revenue Agency (CRA)
To learn how to open an RRSP with moomoo, check out Registered Retirement Savings Plan (RRSP)
Who should open an RRSP?
Choosing to make a contribution to your RRSP can often feel like a stressful decision. Here are a few things to consider before making a contribution.
Do you have an emergency fund? — Make sure you have at least 6 months of expenses set aside for emergencies before making a contribution to your RRSP. Once you contribute, there are penalties for early withdrawals.
Does your employer have RRSP matching? — If your employer is matching your yearly contributions, you should contribute enough to max out your employers' contribution. It is free money on the table, take it!
Do you have an employer or government pension? — If you are already making contributions to your employer or government pension plan, it will lower the maximum amount you can deduct from your RRSP contributions on your yearly income tax filing. Consider lowering your RRSP contributions or prioritizing maxing out your TFSA account.
Are you in a high income tax bracket? — The higher your tax rate, the more you will benefit from contributing towards your RRSP and lowering your income taxes payable. If you are in a low tax bracket, consider maxing out your TFSA first if you still have contribution room left.
What are the benefits of an RRSP?
Now that you know about the RRSP and who can open one, let's review the benefits and how they will help you grow your investments for retirement.
Tax Deductions: Contributions to an RRSP are tax-deductible and will reduce your taxable income when you file your taxes. For example, if you earned $75,000 last year and you contributed $8,000 to your RRSP, you would only pay taxes as if you earned $67,000. This can result in tax-savings every year you contribute.
Tax Deferral: The money you contribute and any investment earnings are tax-deferred until withdrawal, usually at a lower tax rate during retirement when your income is lower.
Compound Growth: Investments in your RRSP can grow tax-free, which increases the compounding growth of your investments over time. Get your money working for you without being held back by taxes.
Spousal RRSP: This allows the partner with the higher income to contribute to an RRSP in their spouse’s name and receive the tax deduction themselves. Income splitting can offer tax advantages to families during retirement by letting spouses split income more evenly.
Home Buyers' Plan (HBP): This allows first-time homebuyers to withdraw tax-free funds up to $35,000 from your RRSP for the purchase of a home, which must be repaid within a specified number of years.
Lifelong Learning Plan (LLP): This allows tax-free withdrawals up to $20,000 ($10,000 per calendar year) from your RRSP to finance full-time training or education for you or your spouse. Like the HBP, these withdrawals are interest-free and must be repaid over a period of time.
What you need to know about RRSP contributions
To fully maximize the benefits of your RRSP, it's important to understand how much you can contribute each year. Because of the tax benefits, the government limits the amount you can put into your RRSP. You can deposit 18% of your earned income from the previous year, up to a maximum of $31,560 for 2024.
Here are a few things to note:
1. Each person will have a different contribution limit. Your RRSP limit is based on 18% of your previous year's total income in your annual tax filing.
2. Your unused contribution room is carried forward to future years. If you miss a year, you can call the CRA to check your personal contribution limit, and contribute more in the future.
3. The maximum contribution amount is determined by the CRA a year in advance. You will have to look up the maximum amount each year to make sure you don't over-contribute.
4. You can over-contribute up to $2,000 beyond your limit without penalty. Exceeding this grace amount will incur a penalty tax of 1% per month on the excess.
5. Contributions should be considered locked-away until age 71, unless you intend to use the Home Buyers Plan or Lifelong Learning Plan. Only contribute if you don't need those funds for a long time.
6. Contributions are deducted from the individual's annual taxable income before taxes are calculated. Contributions lower your income tax payable. If you don't earn an income in Canada, or earn very little, you won't benefit very much from upfront the tax-deduction.
Example: Calculating John's contribution limit for 2024 and 2025
John is employed full time. In 2024, he earned $60,000, pre-tax. To determine his contribution limit, he would go with 18% of $60,000 or $31,560, whichever is less. John has no unused contribution room for his RRSP and no employer pension.
Let's do the math
2024: $60,000 x 18% = $10,800
$10,800 is less than the maximum limit of $31,560, so his RRSP contribution limit is $10,800 for 2024.
Because John doesn’t have any pension adjustments, his total deduction limit is also $10,800. If John makes a $6,000 contribution to his RRSP, he'll have $4,800 unused contribution room.
John is able to carry forward that $4,800 and add it to his contribution limit. If his contribution limit remains $10,800, his RRSP contribution limit will be $15,600 for 2025.
2025: $10,800 + $4,800 carry forward = $15,600
Note: This example is a theoretical scenario and should not be considered investment advice.
What you need to know about RRSP withdrawals
Your Registered Retirement Savings Plan (RRSP) is a powerful part of your retirement strategy. However, like all powers, there are weaknesses. Your RRSP can grow your investments tax-free, but you still have to pay taxes when you withdraw. Your RRSP funds have been tax-deferred until retirement when your income is likely to be lower, with a lower marginal tax rate compared to your working years.
Once you contribute to your RRSP, your funds should be locked away until you turn 71 years old. Any emergency, or early withdrawals will incur fees and penalties.
Once you turn 71, your RRSP will be converted to a Registered Retirement Income Fund (RRIF) which has a minimum mandatory withdrawal amount each year, based on your age and the value of your RRIF. You can also use your RRSP to purchase an annuity, or take a lumpsum cash withdrawal, however the latter will be subject to a relatively high-income tax rate in a single tax year.
It is recommended to withdraw your RRSP in steady amounts each year, to reduce your income taxes payable. You can withdraw the minimum, or choose to withdraw more. Make a schedule that best fits your retirement needs. Larger withdrawals in one year will have a larger tax withheld.
The financial institution will withhold a portion of your withdrawal as a prepayment of the income tax owed. The withholding tax rate varies based on the amount withdrawn and your province of residence.
There are two special programs available with your RRSP. You can withdraw funds tax-free and repay the balance over the next few years.
Home Buyers' Plan (HBP): This allows first-time homebuyers to withdraw tax-free up to $35,000 from your RRSP for the purchase of a home. The program is available to anyone who hasn't purchased a home in the last 10 years, including first-time home buyers. Repayments start the second year after the initial withdrawal.
Lifelong Learning Plan (LLP): This allows tax-free withdrawals up to $20,000 ($10,000 per calendar year) from your RRSP to finance full-time training or education for you or your spouse. Check the CRA website for a list of qualifying educational institutions. Repayments start the fifth year after the initial withdrawal.
What are the common misconceptions of an RRSP?
To better understand how your RRSP will serve your investment objectives, both in the near future and for retirement, let's dispel some of the common misconceptions.
Only for Retirement: Your RRSP is primarily used for saving for your retirement, however the Home Buyer's Plan and the Lifelong Learning Plan give you the opportunity to save up the deposit on your first home, or for your education tuition, all tax-free.
2. Tax-Free Withdrawals: Unlike Tax-Free Savings Accounts (TFSAs), withdrawals from RRSPs are not tax-free, they are tax-deferred. They are taxed as income at your marginal rate.
3. Tax Refunds: Contributions reduce your taxable income, which can result in a tax refund, but tax refunds are not guaranteed. It depends on your total income, deductions, taxes already withheld by your employer, and tax credits for the year.
FAQs
What is the minimum age requirement to contribute to an RRSP?
There is no minimum age limit for contributing to an RRSP. As long as Canadians have earned income and file a tax return, they (or their guardians) can set up an RRSP and make contributions.
When can I withdraw from my RRSP?
You can withdraw funds from your RRSP at any time, and it will be considered taxable income, subject to your marginal tax rate. Also, withdraws before the age of 59.5 may incur a 10% of the value as an early withdrawal penalty.
Is an RRSP the same as a 401(k)?
No, the RRSP is unique to Canada, while the 401(k) is a retirement savings plan for individuals in the United States. However, both plans have similarities in providing tax advantages for retirement savings.
