What is the Registered Retirement Savings Plan (RRSP)?
RRSP stands for Registered Retirement Savings Plan. Its intention is for individuals to save for retirement.
Returns inside the RRSP are tax deferred. The idea is that we draw money from it in retirement, at which time the amount is taxed.
Special situations allow a certain amount to be withdrawn. They include buying your first home, continuing your education, or when you expect your income to fluctuate.
However, you’ll need to deposit the amount you withdraw back into your RRSP within a certain period of time if you don’t want to lose that contribution amount forever.
Who is Eligible for the RRSP?
If you’re filing a Canadian income tax return, you can create an RRSP account at your bank. When you file a tax return to the Canada Revenue Agency, you will receive a Notice of Assessment. On there, you will find the RRSP deduction limit for that year. That is the maximum amount you can contribute to your RRSP until the end of the year.
For example, for the tax return that I filed for the 2015 tax year, it would say that my RRSP deduction limit for 2016 is, say, $5000. So, until the end of 2016, I can only contribute a maximum of $5000.
Be careful not to over-contribute to your RRSP to save hassle for yourself!
What are the Benefits of Investing in the RRSP?
1) Compound Returns in a Tax-Deferred Environment
You grow your savings in a tax-deferred environment, so that you only pay taxes for it when you withdraw. In doing so, you are compounding the returns in the account without worrying about tax until withdrawal.
Ultimately, the RRSP was created for retirement, which means typically, we get at least 30-40 years of compounding depending when you start contributing.
You don’t pay income tax for the amount you contribute to the Registered Retirement Savings Plan.
2) Lower your Tax Bracket
FrugalTrader explains it simply enough in their article, Carry Forward your RRSP Tax Deduction:
“RRSP contributions result in a tax deduction which means that they reduce your income (and taxes owed) for the year. However, since the Canadian tax system is progressive (the more you earn, the higher your tax rate), it may make sense to contribute just enough to lower your income to the next tax level below.”
For example, assuming your income for the 2012 year is $38,000 and you live in British Columbia. Your federal income tax rate is 15% and your provincial income rate is 5.06% for the first $37,013 and 7.7% for the rest. Contributing $987 ($38,000 – $37,013) to your RRSP would defer paying the tax for that amount.
Find out your income tax rate from the Canada Revenue Agency website.
Learn more about the Registered Retirement Savings Plan from the Canada Revenue Agency website. Main topics covered include:
- How to set up an RRSP
- Contributing to an RRSP
- Making Withdrawals
Disclaimer: I am not a certified financial advisor. This article is for educational purposes, so consult a financial advisor and or tax professional if necessary before making any investment decisions.
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