Both 401(k) plans and Registered Retirement Savings Plans (RRSPs) offer tax-advantaged ways for employees to save for retirement. You can think of an RRSP as the Canadian equivalent of their 401(k), and vice versa. However, there are some important differences between these plans, which we’ll explore here.
- Registered Retirement Savings Plans (RRSPs) are essentially the Canadian equivalent of the American 401(k), and vice versa.
- RRSPs and 401(k)s are both retirement savings accounts, and each has similar tax benefits.
- Where 401(k)s and RRSPs differ are in how they work and how they are set up.
- A 401(k) plan is set up and administered by an employer, while an individual can set up an RRSP.
- The annual contribution limit to an RSPP is higher than the annual contribution limit of a 401(k) plan.
401(k) vs. RRSP: Major Similarities
In many ways, 401(k) plans in the United States and RRSPs in Canada are very similar. The RRSP is actually the older of the two, created in 1957 as part of the Canadian Income Tax Act.
RRSPs are registered with the Canadian government and overseen by the Canada Revenue Agency (CRA), which sets the rules on annual contribution limits, contribution timing, and what kinds of investments are allowed.
401(k) plans came along about two decades later, when benefits consultant Ted Benna noticed that the Revenue Act of 1978 made it possible for employers to establish simple, tax-advantaged savings accounts for their employees. Benna created the 401(k) plan and secured Internal Revenue Service (IRS) approval for it.
Though many companies were hesitant to adopt them at first, 401(k) accounts gradually became popular. In 1983, 7.1 million workers participated in a 401(k) plan, a number that grew to 38.9 million by 1993. Data collected by the Bureau of Labor Statistics showed that 69% of private industry workers had access to a 401(k) or similar defined contribution retirement plan in March 2022.
The central idea behind a traditional 401(k) plan and an RRSP is the same, and they have similar tax advantages. First, participants may deduct contributions against their income. For example, if a 401(k) participant’s tax rate is 24%, every $100 that they invest in a 401(k) will save them $24 in taxes, up to their contribution limit. If an RRSP participant’s tax rate is 26%, they’ll save $26 per $100 contribution.
Second, investment growth in both types of plans is tax deferred, so participants are not subject to taxes until they withdraw the money in their retirement years.
A Roth 401(k) has unique tax advantages. Contributions are made with after-tax dollars, and your income tax is not reduced when you contribute. Instead, you receive tax benefits when you make withdrawals in your retirement years, when the withdrawals, including any earnings, are made tax free.
401(k) vs. RRSP: Key Differences
401(k) plans and RRSPs are similar, but they also have some differences in how they work, including who sets up the plan and your maximum contribution limits. Here are some key differences in more detail:
Who Sets the Plan Up
One major difference between an RRSP and a 401(k) is who is responsible for setting up and managing the plan.
- A 401(k) is created and administered by the employer. You can’t establish one yourself unless you’re a business owner or self-employed.
- An RRSP can be set up by an individual at any bank or financial institution. If an employer sets one up, it is called a group RRSP.
Both RRSP and 401(k) plans have annual contribution limits that vary from year to year, but their maximum amounts are different.
- For a 401(k), the limit was $20,500 in 2022, with an additional catch-up contribution of $6,500 for those aged 50 and older, allowing a maximum of $27,000. For tax year 2023, the limit increases to $22,500 and the catch-up contribution to $7,500, which makes the maximum contribution $30,000.
- The RRSP contribution limit for 2022 was $30,780, increasing to $31,560 in 2023.
Another important difference between 401(k) plans and RRSPs is what’s known as their carryforward rules.
- If you don’t contribute the allowable maximum to your 401(k) for a given year, then you’ve lost your chance to do so.
- With an RRSP, you can carry forward a portion of your unused allowance to future years if you didn’t make the maximum contribution in a particular year. This can be a very useful feature because you may be in a higher tax bracket in future years (when you’ll benefit more from the deduction). You may also have more cash to contribute to your retirement savings in later years.
RRSPs and 401(k)s also have different dates when you can no longer contribute. You can no longer contribute to an RRSP after Dec. 31 of the year when you turn 71. With a 401(k), you can contribute to your employer’s plan if you are still working, regardless of your age.
RRSPs are also more lenient about allowing you to take money out early without penalties.
- A 401(k) imposes a 10% early withdrawal penalty, in addition to any income taxes you owe, if you take money out before age 59½, although there are some exceptions to this rule.
- An RRSP doesn’t penalize you if you take the money out before retirement, but you must pay the income taxes that you would have paid if you had not contributed.
When You Reach Retirement Age
Both RRSP and 401(k) plans have certain requirements when participants reach their 70s.
- With a 401(k), you must generally begin withdrawing a certain amount of money from your account by April 1 following the year when you turn 73. Then, you must continue making withdrawals every year thereafter based on your age at the time. These are known as required minimum distributions (RMDs), and failing to follow the rules can result in penalties. The IRS publishes worksheets for determining the amount each year, and the age was most recently increased as part of the SECURE 2.0 Act.
- By the last day of the year when an RRSP holder turns 71, their RRSP balance must be liquidated or shifted to a Registered Retirement Income Fund (RRIF) or an annuity. An RRIF is a retirement fund similar to an annuity contract that pays income to a beneficiary or a number of beneficiaries. If the account is liquidated, the owner will owe taxes on the money right away. If they move it into a RRIF or an annuity, there are no immediate tax consequences, but they will owe tax on the income that they receive over time.
Can an Employer Match Registered Retirement Savings Plan (RRSP) Contributions?
Employers that offer group Registered Retirement Savings Plans (RRSPs) can provide matching contributions, much like employers in the United States can match funds that employees contribute to a 401(k).
What Happens If You Move From the U.S. to Canada or Vice Versa?
If you move from the U.S. to Canada or from Canada to the U.S., you can convert a 401(k) into an RRSP, or vice versa. Keep in mind that the conversion can have complex tax implications, so consider consulting a knowledgeable accountant about how to approach the move.
How Does a Registered Retirement Income Fund (RRIF) Work?
A Registered Retirement Income Fund (RRIF) is an account with a bank, insurance company, or other financial institution that will begin to pay you income in the year when you establish it, and will continue make those payments for the rest of your life. The payments will be taxed as income.
The Bottom Line
RRSPs can be considered the Canadian equivalent of the American 401(k), and vice versa. Both are retirement plans designed to encourage savings with similar tax benefits. However, these plans have some differences, including who can set them up and the maximum annual amounts that you can contribute. If you are moving from the U.S. to Canada or from Canada to the U.S., you can switch from one plan to the other, but you’ll likely face complicated tax consequences.