Registered Retirement Savings Plan (RRSP)

Overview

A Registered Retirement Savings Plan (RRSP) is a way of saving for your retirement. Contributions are tax-deductible and your money will grow tax-free until you withdraw it from your plan. You can also carry forward unused contribution room to future years. Your contribution limit is reported on your Notice of Assessment from the Canada Customs and Revenue Agency. You can also call 1 800 959-8281 (TDD/TTY 1 800 665-0354) or visit the Canada Customs and Revenue Agency's website.

Definition

A Registered Retirement Savings Plan or RRSP is a Canadian investment account that provides some tax benefits for saving for retirement in Canada. RRSP refers to a provision in the Income Tax Act that allows a person to shelter financial property from taxes.

Examples of financial property that can be used with an RRSP are: mutual funds, shares in a company (stocks), bonds, mortgage loans, Labour Sponsored Investment Fund and GIC's.

Calculating RRSP Deduction Limit

A deduction limit is generally calculated as 18% of a person's earned income from the previous tax year, minus any "pension adjustment", up to a specified maximum. This specified maximum has been rising, for 2004 the maximum was $14,500, for 2005 it was $16,500, and in 2006 it was $18,000. After that, it is supposed to be subject to inflation. Any RRSP deductions not taken in a tax year are carried forward indefinitely to future tax years. So, for example, if a person's RRSP deduction limit is $8,000 and he deducts only $3,000, the unused $5,000 deduction is carried forward. Furthermore, it would be increased by the deduction limit as calculated by the formula above.

After filing a tax return (or any adjustments to the tax return), each tax payer receives a Notice of (Re)Assessment from the Canada Revenue Agency, indicating their new RRSP deduction limit.

Limits on Purchase

A RRSP can be contributed to until the annuitant is aged 71.

While it is possible to contribute more than the contributor's deduction limit, it is generally not advised as the excess amount (presently $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 calendar year must be reported on the previous tax year's return, according to CRA regulation. 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 calendar year or held for future use.

Spousal RRSP

A Spousal RRSP allows a higher earner to contribute to an RRSP in the spouse's name. 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.

Options for Your RRSP at Age 71

By the end of the year you turn 71, you have to choose one of the following options for your RRSPs:

• withdraw them;
• transfer them to a RRIF;
• use them to purchase an annuity for life; or
• use them to purchase an annuity spread over a number of years.

When you withdraw funds from your RRSPs, your RRSP issuer will withhold some tax. Your RRSP issuer will not withhold tax on amounts that are transferred directly to a RRIF or that are used to purchase an annuity. You may have to pay tax on the income when you start receiving payments from the RRIF. Enter these payments as income on your return for the year you receive them.

Any amount cashed out from an RRSP or redeemed from an RRIF is fully taxable. However, investments held in an RRIF can continue to grow tax-free indefinitely, as long as a minimum required portion of the account is redeemed every year. At that time, an individual's income is expected to be lower and therefore subjected to less tax.

The 2007 Canadian federal budget passed a law to increase the maximum RRIF conversion age to 71.

Self-Directed RRSP

Many RRSP's are simply registered mutual funds. A "self-directed" RRSP 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.

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. Canadians can borrow, tax-free, up to $20,000 from their RRSP (and another $20,000 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.