The Basics of RRSPs: Registered Retirement Savings Plans Print
Thursday, 17th January 2008 (by J.D.)This article is about Investing, Retirement
This morning we have a little something for our neighbors to the north. This is a guest post from Frugal Trader, who writes about personal finance from a Canadian perspective at Million Dollar Journey.
J.D contacted me to contribute to his retirement account series with an explanation of Canadian RRSPs. An RRSP is the closest thing Canada has to a 401k or Roth/Traditional IRA.
What is an RRSP?
RRSP stands for Registered Retirement Savings Plan. An RRSP account acts just like any investment account, but with differences in the way that the account is taxed and the contribution limits.
How does it work?
The tax advantages of the RRSP are what gives it mass appeal. Every deposit into an RRSP account reduces your taxable income for that year. In other words, if you are in the 40% tax bracket and contributed $5000 for the year, you would receive approximately $2000 back in the form of a tax refund. On top of the tax refund, all investments and distributions can compound tax-free within the RRSP account.
Sounds like a great deal right? The catch is that when you withdraw from the RRSP, the money is taxed as income at your marginal rate. The goal of the RRSP is to start young, let the investments compound tax-free over a number of years, and start withdrawing in later years when you have lower income. This way you get the tax refunds while you are in a higher tax bracket (working years), but pay taxes on the withdrawals while in a lower tax bracket (during retirement).
Who should contribute to an RRSP?
I think that every working person should have an RRSP providing that they are not a permanent low-income earner. Low income earners will have better tax opportunities and government benefits investing outside of an RRSP.
If you are young and just starting out in a low tax bracket, you have two options. Providing that you have contribution room, you can begin contributing but carry forward the tax deductions to be used when you are in a higher tax bracket. Or, you can start a taxable non-registered account and transfer the investments to your RRSP at a later date.
Where can I open an account?
If you are a Canadian resident, most Canadian Discount Brokerages offer self directed RRSP accounts. If you aren’t comfortable picking your own investments, you may want to visit a financial advisor or a local bank to help you out. Most of the big banks offer no-fee, no-minimum RRSP accounts providing that you purchase the bank offered mutual funds. This is actually a great way to start off an RRSP account as you can deposit small amounts on a regular basis.
When the RRSP account grows large enough, you may want to consider moving to a self-directed account to reduce your management fees. As with any government tax breaks, there are well-defined rules that must be followed:
- The contribution limit is 18% of last year’s income up to a maximum of $19,000 for tax year 2007.
- You can find your contribution limit by looking at last year’s (2006) notice of assessment or through CRA directly.
- The contribution deadline for tax year 2007 is 29 Feb 2008.
- You can carry forward any unused contribution room.
- You can over-contribute up to $2,000. (In other words, you can contribute up to $2,000 more than the 18% ceiling.) However, it makes little sense to do so as there are no tax benefits. There is a penalty tax if you exceed the $2,000 over-contribution limit.
- You are forced to collapse your RRSP the year that you turn 71. Instead of withdrawing everything in a lump sum (big taxes), you have the option of converting the RRSP into an RRIF or annuity which can help reduce taxation.
Other Notes:
The RRSP also has other perks like the RRSP Home Buyers Plan (HBP), and the Lifelong Learning Plan (LLP). These plans are out of the scope of this article, but both programs allow the tax free withdrawal of RRSP funds under specific circumstances and providing certain conditions are met.
I hope that you enjoyed and learned something from my RRSP article. If you have any questions, I’ll be hanging around the comments here. Alternatively, feel free to contact me via email, or by leaving a comment on Million Dollar Journey. Please note that I’m not a financial advisor and the advice above is based on my experience and opinion only.

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January 17th, 2008 at 6:04 am
Canada has a 40% tax bracket? Gulp.
January 17th, 2008 at 6:26 am
“You can over-contribute up to $2,000. (In other words, you can contribute up to $2,000 more than the 18% ceiling.) However, it makes little sense to do so as there are no tax benefits. There is a penalty tax if you exceed the $2,000 over-contribution limit.”
Wouldn’t the benefit be the tax free compounding of that 2k?
On a side note, I was under the impression that all contributions made after taking out money under the HBP needed to go to repayment until the full amount was paid off. However, someone was just telling me that you can allocate the required repayment (1/15 of the amount withdrawn) towards your HBP repayment, and any amount over that can be a regular RRSP contribution with the associated tax benefits. Anyone know if that is the case?
@dogatemyfinances, yes, we have higher taxes, but we get ‘perks’ like health care included.
January 17th, 2008 at 7:06 am
@dogatemyfinances, the 40% marginal tax rates also include provincial taxes — the equivalent of state taxes. In Ontario, the highest marginal tax bracket is 46.4%. Compare that to New York, where the highest marginal tax bracket is 46%. See http://www.forbes.com/global/2006/0522/032.html
On average, taxes are higher in Canada, since Ontario is in the middle of the pack tax-wise and New York is at the high-end in the US. However, the tax situation in Canada has improved in the last 15 years, and as sjw said, we do get some additional items from our taxes.
@sjw: the benefit of the 2K overpayment is exactly what you say, the tax-free compounding. In the 90s, the overpayment used to be 8K, and people who could afford it would put 8K into their kids’ RRSPs for that exact reason.
January 17th, 2008 at 7:06 am
Just curious approximately how many Canadian readers you have JD. If you know.
January 17th, 2008 at 7:22 am
sjw,
Yes, you are right, there is the benefit of tax free compounding on the $2k over contribution, but no tax return. Thus the over contribution faces double tax. $2k is deposited with after tax dollars, and faces full taxes again when withdrawn.
I should have said that it would probably more profitable to put that $2k in a non registered account invested in a tax efficient manner would result in a higher return in the long run.
FT
January 17th, 2008 at 7:24 am
Eric, I don’t know exactly how many Canadian readers I have. “Many” is the closest answer I can give. Though a vast majority of GRS readers are from the U.S., there are a surprising number from around the world. (Especially from Australia.)
Actually, I just noticed that Alexa gives stats for use by country. GRS traffic comprises:
United States (67.7% of total GRS traffic)
Canada (6.5%)
United Kingdom (3.9%)
Australia (2.7%)
Malaysia (2.4%)
Others (16.8%)
This wide readership is one reason I often try to keep posts general rather than specific.
January 17th, 2008 at 8:07 am
While I have a self-directed RRSP and consider myself fortunate to have the income and financial discipline to contribute, these retirement vehicles are not for everyone.
Through volunteering with seniors, I’ve come upon & followed the work of Richard Shillington (http://www.shillington.ca) for years as he tries to educate Canadians about RRSPs. While his research doesn’t apply to individuals who have high incomes or pensions (public sector & some large employers), it’s certainly a concern for an astonishing number of Canadians who have poorly funded RRSPs for whatever reason, but particularly if it’s because they have a lower income, or as a result of divorce or other financial catastrophe.
Low income seniors & the consequences of overlooking the benefits of applying for the GIS (Canada):
http://www.carp.ca/display.cfm?documentID=1111&CabinetID=256&LibraryID=70&cityID=0
Is having an RRSP appropriate for all individuals?:
http://rrsp.finance.sympatico.msn.ca/rrsp/article.aspx?cp-documentid=2703080
as well as the links on the left of the site.
Saving is a good thing, but choose your investments and where you keep them (registered versus non-registered) carefully.
January 17th, 2008 at 8:49 am
I am a Canadian reader and this article got my attention! I have been investing into RRSPs and what I really want to know more about …is RRIFs. Are you planning to write something on this or do you know where I can get more info online? Love your site and check in every day.
January 17th, 2008 at 8:59 am
MDJ - congrats on a guest post on this blog - I didn’t imagine anything Canadian would be of any interest here. Maybe I can guest post on RESPs? Lol - that topic bores most Canadians to death…
Just to summarize a bit - the higher your marginal tax rate is, the more benefit you can get from the rrsp. It’s hard to know where the “break even” point for lower income people is because as MDJ stated, it depends on your future income etc.
Very good summary.
Mike
January 17th, 2008 at 9:34 am
I am another Canadian reader and I was thrilled when I saw the title today. Thank you JD for including this guest post, it was very informative and I’m happy to discover another wonderful Canadian PF blog to add to my (small) list of local PF reads. I read primarily American blogs and while the basics of personal finance, debt reduction and frugal living are great I am always wishing for investment advice that is specific to Canada!
January 17th, 2008 at 9:41 am
@Marlene
Basically a RRIF (Registered Retirement Income Fund) is what an RRSP turns into once you retire. You contribute to your RRSP while you still have income and it is saved. Once you want to get the money out, you can convert it to a RRIF from where money can be withdrawn. The remaining investments in the RRIF continue to grow tax-free.
Note that you must convert an RRSP by age 71. I do not think there are any ways to directly open a RRIF.
See http://www.cra-arc.gc.ca/tax/individuals/topics/rrsp/menu-e.html for more details
January 17th, 2008 at 9:54 am
What is the difference between their retirement account and the 401K/Roth Ira here?
January 17th, 2008 at 9:59 am
I think technically we are your neighboUrs to the north!! Thanks for this article.
January 17th, 2008 at 10:07 am
Hello.
Because GRS is publishing canadian stuff I recommend you to research a little about saving options in my country. We get in several financial institutions almost 10% on annual return on fixed deposits of more than 50,000 nuevos soles (nuevos soles is our home currency). Those gainings are totally tax free. (1 us dollar = 2.91 nuevos soles)
Those deposits are insured up to 71,000 nuevos soles.
I currently have several accounts in several banks, some of them earning a little more or some a little less giving me an average annual return of 9.5% TAX FREE
Not bad for sitting in my house reading blogs
Sorry for my english, spanish is my native language.
http://www.peru.com
http://www.viabcp.com
http://www.cajatrujillo.com.pe
http://www.bantra.com
January 17th, 2008 at 10:08 am
I am another Canadian reader and very happy with the article from MDJ. I am also his reader
However, at the beginning I didn’t find “financial bloggers” in Canada. So, first I discovered the GRS and then MDJ. I love both of them.
Thanks again.
January 17th, 2008 at 10:58 am
comic books and canada? are you kidding me?
January 17th, 2008 at 10:58 am
Marlene, there isn’t much to RRIF’s. RRPS’s are forced to collapse the year that you turn 71. From there, you have a few options,
1. withdraw all proceeds (not tax efficient) 2. open an annuity
3. open an RRIF account.
If you decide to open an RRIF account, it will have a set withdrawal schedule based on your total balance and age which increases every year . Even though you are forced to withdraw on an annual basis, it’s more tax efficient than withdrawing lump sum.
January 17th, 2008 at 11:13 am
Jim (and Marlene) you can open up a rrif account at any time but it’s not mandatory to convert an rrsp until you turn 71.
Mike
January 17th, 2008 at 12:51 pm
I’m a Canadian that commutes to the US so I actually have investments within an RRSP and a 401k.
RRSPs and 401ks / IRAs are in fact very similar but the most important factor that distinguishes them in my opinion is the fact that, in Canada, you can withdraw from an RRSP without penalty. You will pay a withholding tax and the amount you withdraw will be added to your income for the year but you will not pay a 15% penalty for early withdrawal as you would with a 401k (though I understand there is some sort of work around to this?)
This fact makes the RRSP a very useful tool for early retirement. Also, it can be used to even out income year to year. For example, someone on maternity leave, with little income, can choose to make a withdrawal from their RRSP and pay very little tax on that withdrawal.
I’m not sure if some of your American readers are aware of some of the “freebies” we get in Canada, including “free” health care as well as one year partially paid (by the gov’t) maternity leave.
AS someone that files taxes in both Canada and the US, I can honestly say that the overall tax rates are not significantly different (for our household anyway) between the two countries yet the “perks” of living in Canada are substantial imo.
January 17th, 2008 at 2:26 pm
Canada has moved its tax rates in recent years. They are cheaper or on par with taxes in the US. Our tax thresholds are also different and we receive many benefits, such as subsidized health care and university.
You only have to pay back the HBP at 1/15th a year. You can also choose to skip a year, but you will pay taxes on the 1/15th for that year.
If you want to use the HBP, here is a trick we used. Contribute the amount you have planned for a downpayment (up to $20k per person). Do not take it out of your RRSP. You should be adding extra to your RRSP if you want to use the HBP, so you don’t rob your retirement. Hold the money in the RRSP for at least 3 months. You will thus get your 40% back in taxes. You can then add that to your RRSP or downpayment. So a $40k downpayment turns into $56k, for example. Yes, you have to pay the $40k back to yourself. But you are essentially giving yourself a loan.
You can do the same thing with the Lifelong Learning Plan. A good strategy if you want to go back to school.
January 17th, 2008 at 5:26 pm
Hey nice post! Nice job being inclusive getrichslowly. That luminous Canuck flag is rather eye catching, was that JD’s or FT’s idea?
AS someone that files taxes in both Canada and the US, I can honestly say that the overall tax rates are not significantly different (for our household anyway) between the two countries yet the “perks” of living in Canada are substantial imo.
Yeah, I seem to be paying basically the same income tax as I did in NYC, but get a whole lot of value up here! Sales taxes are undeniably a killer though.
January 18th, 2008 at 7:47 am
Is it true that contributing to an RRSP can actually put you into a lower tax bracket? I’ve heard people say that, but I’ve never seen it in writing.
Let’s say that you make $40,000 and the lower tax bracket ends at $37,000. If you contribute over $3,000 to RRSPs, can you be taxed at the lower rate for the rest of your earnings? Or am I just dreaming here?
January 18th, 2008 at 9:15 am
hb,
Yes, contributing to RRSPs can put you into lower tax brackets. Here is an example of a few of the tax brackets in Ontario (there are many):
$37,179 - $62,487 : 31.15%
$62,488 - $70,976 : 32.98%
$70,977 - $73,622 : 35.39%
But remember, these are marginal tax brackets so you pay the corresponding tax rate for ony the income within that tax bracket. For example, someone earning $73k that contributed $2k would see a 35.39% reduction in taxes on the entire $2k. If they contributed $5k, $2,977 of it would give them a 35.39% reduction and the rest would give them a 32.98% return. You can see why RRSPs can be so beneficial, especially for higher income earners.
Here’s a link to some tax calculators and tax rates (at the bottom) for all provinces / territories.
http://www.ey.com/global/Content.nsf/Canada/Tax_-_Calculators_-_Overview
January 21st, 2008 at 8:35 am
Recently started reading this blog (don’t remember how I found it, likely a link from another blog) and appreciate the guest blogger. Most finance-related blogs I come across are U.S. based. I’ll check out MDJ and add to my news reader.
Guest blogging is a great method for marketing blogs.
January 23rd, 2008 at 3:14 pm
How many rrsp accounts can one person hold? is there a limit? Could it make sense to have more than one with different organizations/banks? for example, one split spousal in which the lower earning spouse invests, and another in which the higher earner could hold dividends?
February 8th, 2008 at 12:49 pm
I was searching for some basic reading material on RRSP’s and came across this great intro article. Many thanks! Question: Are RRSP investments with banks protected - eg in US, IRAs in a bank are FDIC insured to $250K per individual per institution.
February 29th, 2008 at 9:33 am
Just Learnin: As far as i know, there is no limit to the “number” of rrsp accounts one can hold. The only limit is the contribution room.
Farouk: RRSP’s are typically held in a discount brokerage account. Most, if not all, discount brokerages in Canada are protected by CIPF. CIPF protects accounts for up to $1 million.
December 27th, 2008 at 8:01 am
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