Personal Tax

The Ultimate Guide to RRSPs to Secure Your Retirement

Paul Sharpe, CPA, CA
January 12, 2023

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Discover the power of RRSPs in reducing taxes and building a secure retirement.

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Complete Guide to RRSPs

In this article we take you through everything you need to know about RRSPs.

Read on 📖 or watch Joe 🎥 explain everything you should know about RRSPs 👇

What is an RRSP

Let’s start with a general overview of what the heck RRSPs are before we get into the details.

RRSPs are investing accounts that are made available to Canadians by the Canadian Federal government.

I’ve used this analogy before and I’ll use it again here - I like to think of my RRSP account as a big bucket that I can dump cash into.  

The cash can then be invested in various different types of investments, but it’s all done inside of the bucket.

For example, let’s say I took $1,000 and dumped it into my RRSP bucket.

The RRSP bucket now has $1k of cash sitting in it. I could then use that cash to purchase investments of various types.

Let’s say I purchased $1,000 worth of shares in a publicly traded company like Shopify. The investment is still within the RRSP bucket but the cash has been replaced by the investment in Shopify.

So what’s the point of investing inside of your “RRSP bucket?”

I’ll get to that next.

How RRSPs work

With an RRSP, you get a tax deduction when you transfer money or investments into the registered account. 

In the previous example where I moved $1k of cash into my RRSP bucket, it was called an “RRSP contribution.” With that $1,000 contribution I also get a $1,000 deduction on my personal taxes in the year of the contribution.

This means you’ll pay less personal tax in the year that you make an RRSP contribution. Then, the money inside the RRSP grows tax free while it’s inside the RRSP bucket.

Going back to our example, if I earned dividend income on my Shopify investment, that income would flow into the RRSP bucket. But because it’s still within the RRSP,  I wouldn’t have to pay tax on that income. 

It’s only when you withdraw funds out of your RRSP account that you have to pay personal tax on the withdrawal.

The amount that you withdraw gets added to your personal income for that year.  You then pay tax on the withdrawal amount at your marginal tax rate for that year.  

Recap of How RRSPs Work:

  1. You contribute cash or investments into your RRSP account
  2. You get a personal tax deduction when you contribute to your RRSP
  3. Your investments grow tax free inside of the RRSP
  4. Funds are only taxed when you withdraw them from your RRSP account

What Investment Types Can You Hold In Your RRSP?

Next up we’ll look at what types of investments you want to hold in your RRSP account.

The government has placed some restrictions on the types of investments that can be held within RRSPs.

These include:

  • Cash
  • Mutual funds
  • Securities listed on a designated exchange (TSX, NYSE, etc.)
  • Guaranteed investment certificates (AKA GICs)
  • Bonds
  • Some shares in small business corporations

This is a pretty large list of investments and should cover most investors who aren’t looking for higher risk or alternative investment vehicles.

Who Can Open an RRSP?

Now that you have an idea of what RRSPs are and how they work, let’s look at who is eligible to open an RRSP account.

In Canada, any person who has earned income and is a resident of Canada, is eligible to open and contribute to an RRSP. This includes both employees and self-employed individuals.

To open an RRSP account, you need to have a Social Insurance Number and open the account with a financial institution, such as a bank, credit union, or investment firm. 

It's important to note that the contributions to RRSPs are based on the income reported on your tax return.

If you haven’t filed a tax return in Canada, you won’t have contribution room available yet.  We’ll talk about RRSP contribution room below.

The last thing I’ll mention about opening an RRSP is that there’s also a maximum age limit to contribute to your RRSP.  December 31st of the year that you turn 71 years old is the last day you can contribute to your RRSP.  

After this age you can convert your RRSP to a Registered Retirement Income Fund (RRIF) or an annuity, but that’s a whole other topic to discuss in another video.

Benefits of RRSPs

Investing in an RRSP has two major benefits.

The first is that it allows you to reduce your taxes in the current year and defer paying taxes into the future.  

The second benefit is that your investments are allowed to grow tax free inside of your RRSP account.

Defer Taxes to a Future Year

When you contribute to your RRSP, you receive a tax deduction in the year of the contribution.  

You’ve effectively reduced your taxes in the current year, which means you have more cash to invest or to use for buying stuff.

Then when you withdraw the cash from your RRSP in retirement, that cash is taxed at your marginal tax rate.  You’ve deferred the taxes on that money until retirement.

The tax deduction from RRSP contributions is especially helpful for Canadians who are in high tax brackets.

I’ll use an example to show you why that is the case.

Contribute When Income is Higher

Let’s say that Mark works in Macrodata Refinement at his office in Vancouver.  Mark earns $150,000 per year plus performance bonuses.  

At his income level, Mark’s marginal tax rate is around 41%.  This means he will pay $41 of tax for every additional $100 of income that he earns.

It also means that he saves $41 dollars of tax for every hundred dollars that he contributes to his RRSP.

RRSP Tax Savings Calculation

If Mark contributes $10,000 to his RRSP in 2022, he is going to save $4,100 in income tax from that contribution ($10k x 41%).

Moving ahead a few years, Mark decides to retire in 2030 and will earn pension income of $40,000 per year after that.  

Assuming 2030 tax rates are similar to those in 2022, Mark’s marginal tax rate will only be around 20% due to his lower income level.

Marginal Tax Rates

If Mark withdraws $10,000 from his RRSP after retirement, he will only pay around $2,000 in tax on the $10,000 withdrawal ($10k x 20%).

He contributed $10,000 in 2022 and saved $4,100 in taxes.  

Then when he took the cash out of his RRSP, he was in a lower tax bracket and it only cost him $2,000 in taxes.  

He was better off because he contributed to his RRSP when his income was higher.  He also deferred paying tax on those funds until retirement.

This is how registered retirement savings plans were designed. It’s expected that people will contribute to their RRSP accounts when they are in their highest income earning years. Then when their income drops off at retirement, they can take money out of their RRSP accounts and pay tax at a lower rate.

That’s the plan:

  • Contribute to your RRSP when your income is high.
  • Withdraw funds from your RRSP when your income is lower.

Investments Grow Tax Free Inside of Your RRSP

The next benefit of RRSPs is that your funds are allowed to grow inside of the RRSP tax free.

Any investment income earned within an RRSP (such as interest, dividends, and capital gains) is not subject to tax as long as the funds remain in the plan. This tax-free growth can help your savings grow faster than if they were subject to taxes.

The tax comes in when you withdraw funds from your RRSP. We discuss withdrawals and tax on withdrawals in detail below.

RRSP Contributions

Let’s talk a bit more about RRSP contributions.

Contribution Limits

Each year you will have limits on the maximum amount that you can contribute to your RRSP without incurring penalties.

The contribution limit for a given year is typically 18% of your “earned income” from the previous year, up to a dollar maximum that is set by the CRA for that year. 

For the 2023 tax year, the contribution limit is 18% of your earned income from 2022 up to a maximum of $30,780.

For people who haven’t used their full contribution room, the unused portion of the contribution limit is carried forward to future years. 

You can find your current RRSP contribution limit in your notice of assessment from the CRA. 

It’s calculated based on your previous years’ income and previous RRSP contributions less any pension adjustments that may exist.

RRSP Contribution Room on Notice of Assessment

Penalties for Over Contributing

It's also important to note that any RRSP contributions made above your contribution limit will be subject to a penalty of 1% per month.

The government provides a bit of wiggle room by allowing you to contribute $2,000 above your limit before penalties kick in.  However, the $2,000 amount can’t be deducted from your income so it’s still important to stay within your contribution limits.

Penalties can add up quickly, too. 

For example, if you overcontribute to your RRSP by $12,000, you would receive the $2,000 of wiggle room, but then would be assessed a penalty on the remaining $10,000 of overcontribution.

That penalty would be equal to 1% of the $10,000 overcontribution, per month! 

That’s a penalty of $100 per month until you withdraw that excess amount.  This is why it’s very important to keep track of your RRSP contributions and contribution limits.

You can check your most recent notice of assessment from CRA to see your available RRSP contribution room. 

Spousal RRSP Contributions

A spousal RRSP is a type of RRSP that is set up in the name of one spouse or common-law partner for the benefit of the other. 

Spousal RRSP contributions are made by the higher income earner to provide retirement income for both partners when they reach retirement age.

The higher-income partner makes contributions to the spousal RRSP, and also claims the deductions on their tax return. 

When the funds are withdrawn, they are taxed in the hands of the lower-income partner, who will likely be in a lower tax bracket.

The goal is to even out retirement savings between the two partners. This allows the couple to withdraw a similar amount of money from their RRSPs when they retire which can reduce their overall tax burden.

When making contributions to a spousal RRSP:

  • The contribution is made by the higher income earner
  • The contribution is made to an RRSP in the name of the lower income spouse
  • The contribution room of the higher income earner must be sufficient to accommodate the contribution

One last thing to be aware of for spousal RRSPs - there is also a three-year attribution rule for withdrawals. 

This rule says that if the lower income spouse withdraws funds within three years of the contribution, the withdrawal will be taxed as income of the higher income earner.

Spousal RRSPs are good to be aware of if one spouse earns significantly more or has significantly more retirement savings than the other.

Contribution Deadlines

For contributions to be deductible on your current year’s tax return, they can be made throughout the current year and all the way up to March 1st of the following year.

For example, if I contributed $5,000 on July 31, 2022 and another $5,000 on February 28, 2023, I could deduct $10k from my 2022 income (assuming I had enough contribution room available).

RRSP Withdrawals

Let’s move on to RRSP withdrawals.  You’ve contributed cash to your RRSP, invested it and watched it grow.  Now you’d like to withdraw those funds to use for retirement or maybe other purposes.  There is some important information that you should know before doing so.

Income Tax on Withdrawals

Withdrawals from an RRSP are typically subject to income tax. If you withdraw money from your RRSP before you reach the age of 71, the withdrawals will be subject to income tax, paid at your marginal tax rates. 

Withholding Tax on Withdrawals

If you withdraw money from your RRSP before your RRSP matures at age 71, you may also have to pay a withholding tax along with income tax. 

For Canadians outside of Quebec, the withholding tax rate is:

  • 10% on amounts up to $5,000
  • 20% on amounts between $5,000 and $15,000, and
  • 30% on amounts over $15,000

If you withdraw $20k from your RRSP at age 45, you would pay $4,000 of withholding tax on your withdrawal.

RRSP Withholding Tax Calculation

When you withdraw from your RRSP, your financial institution will provide a T4RSP showing the amount you withdrew, and how much tax was withheld. 

You will need to declare the withdrawal amount on your personal tax return in the calendar year that you took out the funds. 

The good news is that the withholding tax is treated the same as regular income tax that you pay.  If you’ve paid more tax than was necessary upon filing your tax return, you’ll get a refund for the amount of the overpaid tax.

RRSP Contribution Room Is Lost

Another important consideration on withdrawals is that you don’t get your contribution room back when you withdraw funds from your RRSP.

The Canada Revenue Agency only lets you count that contribution once - you can’t add back the amount of a withdrawal to your existing contribution room. 

This means you’ll decrease the amount of possible funds in your RRSP, reducing the potential tax-free growth you would otherwise enjoy.

Taking money out of your RRSP account before retirement can impact your long-term retirement savings. 

It’s a good idea to look for other ways to fund your cash needs before taking money out of your RRSP account.  

The Home Buyers’ Plan

The Home Buyers' Plan (or HBP) is a program offered by the Canadian government that allows first-time home buyers to withdraw up to $35,000 from their RRSP tax-free to use towards the purchase of a home. 

The withdrawal amount is considered a loan, and must be repaid to your RRSP over a period of 15 years.  

To be eligible for the HBP, you must meet the following criteria:

  • You must be a first-time home buyer, or have not owned a home that you lived in within the last five years
  • You must have a written agreement to buy or build a qualifying home for yourself
  • You must intend to occupy the home as your principal place of residence within one year of buying or building it
  • You must not have previously participated in the Home Buyers’ Plan

You can withdraw up to $35,000 from your RRSP under this program.  

If you’re married or have a common-law partner, it’s also possible to split the withdrawal between the two of you.  You can each withdraw up to $35,000, allowing you to access up to $70,000 towards the purchase of your home.

You will need to start repaying the borrowed funds to your RRSP after two years. You’ll find the required payment amounts on your annual notice of assessment. 

RRSP Home Buyers' Plan Statement

If you don't make the required annual repayment, that same payment amount will be included in your income, and will be subject to tax. 

The Lifelong Learning Plan

The Lifelong Learning Plan (or LLP) is a similar program offered by the Canadian government.

It allows individuals to borrow funds from their RRSP to finance their education or training. These funds also have to be either repaid or included in your income if not repaid.

The LLP is designed to help individuals return to school or upgrade by allowing them to withdraw from their RRSP without paying tax in that year.

To be eligible for the LLP, you must meet the following criteria:

  • You must be a resident of Canada
  • You or your spouse or common-law partner must have contributed to an RRSP
  • You must be enrolled in a qualifying educational program on a full-time or part-time basis

Under the LLP, you can withdraw up to $10,000 per calendar year, to a maximum of $20,000 in total.

Withdrawals under the LLP must be used within a specific period of time, generally within a four-year period. If not used within that time frame, the withdrawals will be considered taxable income.

The borrowed funds will need to be repaid to your RRSP over a period of 10 years.  Generally, you will repay 1/10th of the total withdrawal amount each year.

Repayment starts the earlier of when you cease to be a qualifying student or the fifth year after your first LLP withdrawal.

You will receive an LLP Statement of Account each year with your notice of assessment. This statement will show your withdrawals, LLP balance, and the amount you have to repay the following year.

RRSP Lifelong Learning Plan Statement

How to Use Your RRSP to Save Taxes

Time to summarize some of the important bits.  There are several ways to use your Registered Retirement Savings Plan (RRSP) to save taxes.

Tax Deductible Contributions

The most common way to use an RRSP to save taxes is by making contributions to the plan. When you make contributions to an RRSP, you can deduct the amount of the contribution from your income, which can result in a lower tax bill.

Income splitting with Spousal RRSPs

By contributing to an RRSP in the name of a lower income spouse or common-law partner, you can shift income to a lower tax bracket, which can result in a lower overall tax bill for both partners.

Tax Deferred Growth from RRSPs

Any investment income earned within an RRSP is not subject to tax until the funds are withdrawn. This means that investments within an RRSP have the opportunity to grow tax-free, which can result in a larger sum of money being available for use in retirement.

Home Buyers' Plan and Lifelong Learning Plan 

By meeting the conditions of the Home Buyers' Plan and Lifelong Learning Plan, you can withdraw funds from your RRSP to buy a home or finance your education without having to pay taxes on the withdrawal.

Final Thoughts

You should now have a good basic understanding of how RRSPs work and how you can benefit from them.

In future articles we’ll continue to dive into other ways for you to save tax and build wealth, so check back here or subscribe to our YouTube channel where we post videos on these same topics.  

We’re also here to provide general guidance on the tax side of things so please don’t hesitate to send us your questions in the comments below.

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Article by
Paul Sharpe, CPA, CA
Originally published
January 12, 2023
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