Canadians are encouraged to save for retirement using a savings vehicle called the Registered Retirement Savings Plan (RRSP).
Your RRSP is basically a savings account. What makes it different from other savings accounts is that it’s “registered.” This means our Federal Government and their folks at the Canada Revenue Agency know you’re putting money aside for your retirement, and celebrate this by offering a tax credit each year for the amount you contribute.
Many of us make annual contributions, maybe even automatic contributions and enter the amount on our tax return as a deduction. But otherwise, we don’t pay much attention to the RRSP.
Ever wonder what’s happening in your Registered Retirement Savings Plan, when you’re not looking?
The truth is, nothing will happen, without directions!
An RRSP is simply a receptacle to help you set aside money for retirement. How that money is invested for growth is up to you. Credit unions, banks, and some employers can set up the RRSP. Then you need to ensure that, within that ‘savings plan’, the mix of investments is appropriate. Depending on your RRSP provider, holdings within your RRSP can be any or a mix of:
- Cash
- GICs
- Gold and silver
- Treasury bills (T-bills)
- Bonds (including savings bonds, government bonds, corporate bonds and strip bonds)
- Mutual funds (only RRSP-eligible ones)
- Equities (both Canadian and foreign stocks)
- Mortgage-backed securities
- Income trusts
Because you’re saving for the future, all the returns these investments provide are automatically reinvested in your RRSP (and while they remain in your plan, they grow tax-free). In a “self-directed” RRSP, you take a more active role in choosing the asset mix. In any RRSP (even self-directed) there are fees associated with managing your plan. When you set up and review your plan, make sure you clarify what you’ll pay in set-up fees, administration fees, management fees, sales charges, commission and service charges.
Tax-free growth – for now
As mentioned above, RRSPs encourage Canadians to save for retirement by allowing us to deduct our contributions (up to a limit) from our taxable income and enjoy tax-free growth and compounding while the investments remain inside the plan. When we withdraw from our RRSPs in retirement – that’s when we pay the tax. The premise is to save at the peak of our earning power (while we’re in a higher tax bracket), and withdraw when our income – and tax rate – are lower.
It’s important to pay attention to all your future sources of retirement income: your pension, Canada Pension Plan (CPP), Old Age Security (OAS), Guaranteed Income Supplement (GIS), Tax-Free Savings Account and RRSP holdings. These sources will combine to make up your income in retirement, and will be taxed accordingly.
Saving money for two
Common-law partners and married couples who are planning for retirement together are advised to save equivalent RRSP amounts – so retirement income is split and taxed at a lower rate. Many Canadian couples don’t earn equal amounts during their years of saving; in some cases, there’s only one earner in the family. To address this, the higher-income spouse can set up a Spousal RRSP, deducting contributions off their (higher) taxable income, while building up their spouse’s retirement savings.
Ups and downs that you’ll want to stay on top of
Like any investment portfolio, you’ll want a balance of growth and safety within your RRSP. In your 20s and 30s, you’re planning for an event decades away, so your risk-tolerance for investing will be higher. As you get close to retirement, when you’ll rely on your RRSP account to provide income, make sure you work with your advisor to rebalance your holdings for a more conservative, lower-risk and reliable portfolio.
Inching towards an expiry date
RRSP accounts have an expiry date: you must close your RRSP account the year you turn 71. At this point, you can transfer your savings into a Registered Retirement Income Fund (RRIF). Annual minimum withdrawals from your RRIF are mandatory and will be taxed as income – but thanks to your savvy financial planning, you’ll be in a lower tax bracket and so taxed at a lower rate.
Withdrawing money before you retire
RRSPs are designed to help you plan and save for your retirement, so it’s not easy nor financially advantageous to pull money out of your plan before you retire. However, the rules have been set so you can borrow from your own RRSP to buy your first home, or to pay for your own education. With the Home Buyers’ Plan and the Lifelong Learning Plan, you can ‘borrow’ from your own plan, tax-free and interest-free, provided you repay the amount back to your RRSP within a set time.
Registered Retirement Savings Plans can be a smart tax shelter and crucial future income source. If you’re ready to set up an RRSP, add a Spousal RRSP, or have questions about planning for the future, get in touch with us! We’re here to help.
Mutual funds are offered through Credential Asset Management Inc. Mutual funds, financial planning, and other securities are offered through Credential Securities Inc. Credential Securities Inc. is a Member of the Canadian Investor Protection Fund.