A Registered Retirement Savings Plan (RRSP) is a type of Canadian account for holding savings and investment assets. Introduced in 1957, the RRSP’s purpose is to promote savings for retirement by employees and self-employed people. It must comply with a variety of restrictions stipulated in the Canadian Income Tax Act. Rules determine the maximum contributions, the timing of contributions, the assets allowed, and the eventual conversion to a Registered Retirement Income Fund (RRIF) at age 71. Approved assets include savings accounts, guaranteed investment certificates (GICs), bonds, mortgage loans, mutual funds, income trusts, corporate shares, foreign currency and labour-sponsored funds.
RRSPs have four effects:
- Taxes on earned income, i.e., income from employment or self-employment to the extent contributed to the plan, are deferred until the eventual withdrawals from the plan. Taxes are deferred through a deduction claimed in calculating taxable income, i.e., amounts contributed are not subject to income tax in the year they are contributed.
- Income earned inside the plan is not taxed while within the plan
- The contributor’s marginal tax rate when withdrawing funds may be higher (or lower) than the tax rate the contributor paid when making the original contribution.
- Canada has a variety of programs available to retired people whose benefits decrease as their income increases. By deferring the income until retirement, the additional income created at that time may reduce those benefits.
An alternate understanding and calculation of net benefits exists that disagrees with the received wisdom.
For the most part, contributions to RRSPs are deductible from taxable income, reducing income tax payable. Because Canada has a progressive tax system, taxes are reduced at the highest marginal rate. Increases in the value of the plan assets (whether capital gains, interest income or other) are not subject to income or other taxes in Canada while inside the accounts. Disbursements from an RRSP are taxable as income at the time of withdrawal.
This tax system is similar to accounts in other countries, all of which are known as tax-deferred accounts, because contributions are considered to have been made with savings from before-tax income e.g., 401(k) and Individual Retirement Accounts in the U.S., Self-invested personal pensions in the UK and Superannuation in Australia.
RRSP accounts can be set up with either one or two associated individuals:
An Individual RRSP is associated with only a single person, called an account holder. With Individual RRSPs, the account holder is also called a contributor, as only they contribute money to their RRSP.
A Spousal RRSP allows a higher earner, called a spousal contributor, to contribute to an RRSP in their spouse’s name. In this case, it is the spouse who is the account holder. The spouse can withdraw the funds, subject to tax, after a holding period. A spousal RRSP is a means of splitting income in retirement: By dividing investment properties between both spouses each spouse will receive half the income, and thus the marginal tax rate will be lower than if one spouse earned all of the income.
In a Group RRSP, an employer arranges for employees to make contributions, as they wish, through a schedule of regular payroll deductions. The employee can decide the size of contribution per year and the employer will deduct an amount accordingly and submit it to the investment manager selected to administer the group account. The contribution is then deposited into the employee’s individual account and invested as specified.
The primary difference with a group plan is that the contributor realizes the tax savings immediately, instead of having to wait until the end of the tax year.
Legislation was introduced during the 41st Canadian Parliament in 2011 to create Pooled Retirement Pension Plans (PRPP). PRPPs would be aimed at employees and employers in small businesses, and at self-employed people.
A RRSP deduction limit is the maximum amount of RRSP contributions that can be claimed on a tax return for a given tax year.
A deduction limit is calculated as the unused deduction limit from the prior year (which includes all unused deductions going back 10 years), plus 18% of a person’s earned income from the previous calendar year up to a specified maximum, minus any pension adjustment (PA) and past service pension adjustment (PSPA), plus pension adjustment reversals (PAR). The CRA calculates the RRSP deduction limit for the next year and prints it on every Notice of Assessment or Reassessment, provided the taxpayer is aged 71 years or younger. It is also recalculated and a copy mailed in certain cases such as when a PSPA or PAR is issued.
After 2010 the RRSP contribution limit is indexed to the annual increase in the average wage.
After filing a tax return (or any adjustments to the tax return), each taxpayer receives a Notice of (Re)Assessment from the Canada Revenue Agency, indicating their new RRSP deduction limit.
While it is possible to contribute more than the contributor’s deduction limit, it is generally not advised as the excess amount ($2,000 over the deduction limit) is subject to a significant penalty tax removing all benefits (1% per month on the overage amount).
RRSP contributions within the first 60 days of the tax year (which may or may not be the calendar year) must be reported on the previous year’s return, according to the Income Tax Act. Such contributions may also be used as deduction for the previous tax year. Note that reporting and using are two different things. All other contributions may be used in the same tax year or held for future use.
An account holder is able to cash out an amount from an RRSP at any age. However, any amount withdrawn qualifies as taxable income and is therefore subject to withholding tax.
Before the end of the year the account holder turns 71, the RRSP must either be cashed out or transferred to a Registered Retirement Income Fund (RRIF) or an annuity. Until 2007, account holders were required to make this decision at age 69 rather than 71.
Investments held in a RRIF can continue to grow tax-free indefinitely, though an obligatory minimum RRIF withdrawal amount is cashed out and sent to the account holder each year. At that time, an individual’s income is expected to be lower and therefore subjected to less tax.
Special withdrawal programs
Home Buyer’s Plan
While the original purpose of RRSPs was to help Canadians save for retirement, it is possible to use RRSP funds to help purchase one’s first home under what is known as the Home Buyer’s Plan (HBP). An RRSP holder can borrow, tax-free, up to $25,000 from their RRSP (and another $25,000 from a spousal RRSP) towards buying their residence. This loan has to be repaid within 15 years after two years of grace. Contrary to popular belief, this plan can be used more than once per lifetime, as long as the borrower did not own a residence in the previous five years, and has fully repaid any previous loans under this plan.
Lifelong Learning Plan
Similarly to the Home Buyer’s Plan, the Life-Long Learning Plan (LLP) allows for temporary diversions of tax-free funds from an RRSP. This program allows individuals to borrow from an RRSP to go or return to post-secondary school. The user may withdraw up to $10,000 per year to a maximum of $20,000. The first repayment under the LLP will be due at the earliest of the following two dates.
- 60 days after the fifth year following the first withdrawal
- the second year after the last year the student was enrolled in full-time studies
Both Individual and Spousal RRSPs can be held in one of three account structures. It should be noted that one or more of the account types below may not be an option depending on what type of investment instrument (example stocks, mutual funds, bonds) is being held inside the RRSP.
Client-held, or client-name accounts, exist when an account holder uses their RRSP contributions to purchase an investment with a particular investment company. Each time that an individual uses RRSP contribution money to purchase an investment at a different fund company, it results in a separate client-held account being opened. For example, if an individual buys investment # 1 with one company and investment # 2 with another, this would result in the individual having two separate RRSP accounts held with two different companies.
The main benefits of client-name accounts is that they do not generally incur annual fees or “exit fees”, the investment is registered with the trustee in the client’s name instead of the “dealer’s” name and therefore, client-name investments are not subject to bankruptcy issues if the dealer goes bankrupt. Another benefit is that a Dealer Statement generated quarterly by the Mutual Fund Dealer; and Exempt Market Dealer contain all investment activity (buy, sell, switch) through that dealer for ease of tracking investments. The Dealer Statement contains all types of plans for registered investments (RRSP, RRIF, Tax-Free Savings Account, Locked-in Retirement Acoount, LIfe Income Fund) and non-registered investments thereby making it easy to track investments in one place. Online client access is available at most client name dealers.
Generally, client-held accounts are for mutual funds and exempt products only; therefore, if an investor holds stocks and bonds along with mutual funds or exempt products, a Nominee or Intermediary account is most beneficial for ease of tracking all types of investments in one place.
Nominee accounts are so named because individuals with this type of account nominate a nominee, usually one of Canada’s five major banks or a major investment dealer, to hold a number of different investments in a single account. For example, if an individual buys investment # 1 with one company and investment #2 with another, both investments are held in a single RRSP account with the nominee, a chartered bank.
The main benefit of a nominee account is the ability to keep track of all RRSP investments within a single account. The main detriment is that nominee accounts often incur annual fees.
A “self-directed” RRSP (SDRSP) is a special kind of nominee account. It is essentially a trading account at a brokerage that has tax-sheltered status. The holder of a self-directed RRSP instructs the brokerage to buy and sell securities on their behalf as with any brokerage account. The reason that it is described as “self-directed” is that the holder of this kind of RRSP directs all the investment decisions themselves, and does not normally have the service of an investment advisor.
Intermediary accounts are essentially identical in function to nominee accounts. The reason investors would have an intermediary account instead of a nominee account has to do with the investment advisor they deal with, as advisors not aligned with a major bank or investment dealer may not have the logistical ability to offer nominee accounts to their clients.
As a result, the advisor will approach an intermediary company which is able to offer the investor identical benefits as those offered by a nominee account. The two main Canadian financial institutions that offer intermediary services are B2B Bank and Canadian Western Trust.
The main benefits and detriments of intermediary accounts are identical as those offered by nominee accounts.
It is possible to have an RRSP roll over to an adult dependent survivor, child or grandchild, as it would to a spouse. This was made possible in 2003 and there are various Income Tax Act (ITA) requirements to allow this to take place. The new registered asset could result in provincial benefits being cut off. In many cases a court application to have someone appointed guardian of the child’s property and person would be necessary to provide a legally authorized party to manage the asset if the child is deemed incompetent to do so. This possibility has an impact on the overall estate plan and often the distribution of the estate.
Acquiring this asset may also impact the adult dependent child’s eligibility for provincial assistance programs. A Henson trust may be useful for enabling the adult dependent child to receive RRSP rollovers and still be eligible for provincial social assistance programs such as Ontario Disability Support Program (ODSP). A Lifetime Benefit Trust (LBT) is a new option that may be valuable for leaving a personal trust in a will for a special needs, financially dependent child, grandchild or spouse. It has the added benefit that RRSP assets dedicated to the LBT could be protected from creditors.