All About RRSPs - What You Need To Know
Created in 1957 to promote savings for retirement by employees and self-employed people, the tax advantages offered by a Registered Retirement Savings Plan (RRSP) have stood the test of time and remain an effective tool to motivate people to save for their retirement and save on taxes in the current year, and in the future.
RRSPs are usually seen as a win/win proposition – save taxes in the near team and save money for the long term to ensure you have enough money to retire.
“What the government did more than 60 years ago to encourage people to save money for their retirement, is probably even more relevant for people today,” say Sean Bjorklund, vice president of Private Wealth for Connect First. “Research indicates many Canadians are not saving for their retirement at all, or not saving enough. And few of us would have an adequate standard of living solely relying on the Canada Pension Plan and Old Age Security in our later years, so retirement savings can be a good place to focus when it comes to your overall financial health.”
Retirement savings is an important topic you need to know about, so let’s start with a primer on RRSPs:
RRSP knowledge –
the next level
- RRSPs can also be used as a tool for income splitting between spouses or common law partners. There are two parts to this strategy:
- It provides a way for higher-earning spouse or common law partner to save money for retirement for the lower-earning spouse to provide similar income and tax rates for both during retirement.
- The higher-earning spouse can claim the tax deduction against their income the year the contribution is made, lowering their tax bill in the current year. Spousal RRSPs generally mean less taxes when you make the contribution, and less taxes during retirement.
- If you haven’t made your maximum RRSP contribution in previous years, the CRA kindly carries it forward to future years. And they provide that number to you on your most recent Notice of Assessment. That means during years where you make more income, you may have the option to make a larger RRSP contribution to catch up on your retirement savings and lower your tax bill. There are penalties for over contributing, so make sure you know what your available contribution room is for that year.
- When you reach the age of 71, your RRSPs must be liquidated. Most people choose to convert their RRSPs to Registered Retirement Income Funds (RRIFs) to continue sheltering their savings from taxation. RRIFs require minimum annual withdrawals based on your age, and withdrawals will be taxed as income the year the money is withdrawn.
“There is no one-size-fits all approach to planning for retirement,” says Sean. “When you get into things like maximizing contributions, tax savings, and income splitting, it makes a lot of sense to talk with an expert to determine what the right plan and scenario is for you and adjust it over time.”
RRSPs vs. TFSAs
- You’ve read enough to understand your level of income and tax rate during retirement factor in substantially to how successful RRSPs will be for you as a tax-saving tool. This is where Tax Free Saving Accounts (TFSAs) may come in.
- If you put your savings in a TFSA, you don’t have to pay taxes on the returns that investment makes. For instance, if your $5,000 investment grows to $6000 over time, when you withdraw that money, you don’t have to pay taxes on the growth amount.
- Like RRSPs, TFSAs can hold a myriad of investments, including stocks, bonds, GICS, and mutual funds. They also have annual contribution limits. For 2021, it is $6000, but you may be eligible for cumulative contribution room that has accrued since they were introduced in 2009.
- RRSPs can be a good vehicle for investing for your retirement, but TFSAs can also be a great option and be part of your retirement savings mix – both pre- and post-retirement.
- A TFSA can also be the right choice if you are in a lower income bracket and income tax savings would make less of a difference to you than saving tax on the growth of your savings.
“We meet with clients in their 60s and 70s who wish TFSA’s were available to them earlier,” says Sean. “Protecting yourself from paying taxes in the future is as important, maybe more important, than postponing taxes until later.”
RRSPs – key takeaways
- Most people must save money to fund their retirement. Not having savings for when you stop working can have a profound impact on your quality of life in your later years.
- RRSPs provide a vehicle to encourage you to save money and while reducing taxes during your high earning years. If your income is lower in your retirement years, you could end up paying less income taxes overall.
- With RRSP contributions being an income tax deduction, you might get a tax return from the government. RRSPs can an easy way for you to ‘find money’ to fund your retirement savings.
- RRSPs aren’t the only option for retirement savings. TFSA’s can also be used as effective vehicles to save your money and reduce taxes.
- Starting early is always better, but there are ways to catch up and make the most of your income earning years.
- There are a lot of factors at play when it comes to retirement planning, including changes in government legislation, economic trends, and what’s happening in your life. It’s a smart idea to get regular advice on your retirement savings plan from financial experts who can help. Having money available for when you stop working is an important part of your financial wellbeing.