What is a Registered Retirement Savings Plan (RRSP)
A Registered Retirement Savings Plan (RRSP) is a retirement savings and investing vehicle for employees and the self-employed in Canada. Pre-tax money is placed into an RRSP and grows tax free until withdrawal, at which time it is taxed at the marginal rate. Registered Retirement Savings Plans have many features in common with 401(k) plans in the United States, but also some key differences.
BREAKING DOWN Registered Retirement Savings Plan (RRSP)
Registered Retirement Savings Plans were created in 1957 as part of the Canadian Income Tax Act. They are registered with the Canadian government and overseen by the Canada Revenue Agency (CRA), which sets rules governing annual contribution limits, contribution timing and what assets are allowed. RRSP information may be found here.
RRSPs have two main tax advantages: Contributors may deduct contributions against their income. For example, if a contributor's tax rate is 40%, every $100 he or she invests in an RRSP will save that person $40 in taxes, up to his or her contribution limit. And the growth of RRSP investments is tax sheltered. Unlike with non-RRSP investments, returns are exempt from any capital-gains tax, dividend tax or income tax. This means that investments under RRSPs compound at a pre-tax rate.
In effect, RRSP contributors delay the payment of taxes until retirement, when their marginal tax rate will be lower than during their working years. The Government of Canada has provided this tax deferral to Canadians to encourage saving for retirement, which will help the population rely less on the Canadian Pension Plan to fund retirement.
There are a number of RRSP types, but generally, they are set up by one or two associated people (usually individuals or spouses).
- An Individual RRSP it set up by a single person who is both the account holder and the contributor.
- A Spousal RRSP provides benefits for a single spouse and also a tax benefit for both spouses. A high-earner (spousal contributor) may contribute to a Spousal RRSP in their spouse's name (the account holder). Since retirement income is divided evenly, each spouse can benefit from a lower marginal tax rate.
- A Group RRSP is set up by an employer for employees and is funded with payroll deductions, much like a 401(k) plan in the U.S. It is administered by an investment manager and affords contributors the advantage of immediate tax savings.
- A Pooled RRSP, created in 2011, is an option created for small business employees and employers, as well as the self-employed.
Registered Retirement Savings Plan: Approved Assets
Several types of investment and investment accounts are permitted in RRSPs. They include:
- Mutual funds
- Exchange-traded funds
- Savings accounts
- Mortgage loans
- Income trusts
- Guaranteed investment certificates
- Foreign currency
- Labour-sponsored funds
Registered Retirement Savings Plan: Contribution & Withdrawal
The RRSP contribution limit for 2018 is 18% of the earned income an individual has reported on their 2017 tax return, up to a maximum of $26,230. In 2019, that figure rises to $26,500. It is possible to contribute more, but additional sums over $2,000 will be hit with penalties.
An RRSP account holder may withdraw money or investments at any age. Any sum is included as taxable income in the year of the withdrawal, unless the money is used to buy or build a home or for education (with some conditions).
In the year an RRSP holder turns 71, the RRSP balance must be liquidated or shifted to a Registered Retirement Income Fund (RRIF) or to an annuity.
Registered Retirement Savings Plan: 401(k) Differences
- U.S. RRSPs may be set up via a financial institution; 401(k)s are set up by employers.
- RRSP contribution limits may be carried forward.
- Contribution limits for RRSPs are more liberal (based on a percentage of previous year's income; the 401(k) limit is fixed to a specific dollar amount.
- RRSP contributions may come from payroll deductions or cash contributions (which may lead to a tax rebate); 401(k)s are funded with payroll deductions.
- 401(k)s have early withdrawal penalties (though there are exceptions); RRSPs do not.