Registered retirement savings plans: The basics and beyond

Registered retirement savings plans (RRSPs) have been available to Canadians for more than half a century, and for many people, they are the backbone of a retirement savings strategy. However, if you are new to investing, you may not be sure of what exactly an RRSP is. So, let’s start with the basics.

The basics: What are RRSPs and how do they work?

Registered retirement savings plans (RRSPs) are Canadian retirement savings and investment plans that offer tax advantages and are registered with the Canadian government.

 The advantages of RRSPs 

• RRSPs offer several advantages for investors, including:
• Tax advantaged retirement savings account
• Tax deductions on contributions
• Tax-deferred growth
• Tax-free rollover to surviving spouse when named beneficiary of a decedent’s RRSP assets
• Direct transfers of a decedent’s RRSP assets to a beneficiary without going through the probate process
• Several different types of RRSPs from which to choose
• Funding home purchases and education goals (more on this below)
• Helping family members who are disabled (more on this below)
• Potential to qualify for other benefits (more on this below)

Establishing an RRSP

You can set up an RRSP account if you have reached the age of majority for the province in which you reside. At Edward Jones we can help you understand the basics and beyond of setting up an RRSP, as well as the various types of RRSPs available, along with qualified investment options for each.

Types of RRSPs

At a high level, there are four basic types of RRSPs:

• Individual RRSPs are set up for you by a financial advisor and funded by you.
• Spousal RRSPs are set up by a financial advisor for your spouse/common-law partner; spousal and regular contributions can be made to a Spousal RRSP using your respective contribution rooms.
• Group RRSPs are established by employers to benefit employees and are held off-book with an Edward Jones preferred vendor.
• Self-directed RRSPs are set up for you by a financial advisor, and enable you to choose and oversee your own investment portfolio.

Contribution deadlines and rules for RRSPs

The annual contribution deadline for an RRSP is 60 days after December 31 of the previous year. Thus, contributions to an RRSP can be made at any time during the calendar year up until the first 60 days of the following year. The contribution deadline for 2022 is March 1, 2023.

An RRSP matures, i.e., reaches the end of its term and becomes payable, on December 31 of the year in which the RRSP holder turns 71. At that time, contributions can no longer be made to the RRSP. They can, however, still be made to a spouse's or common-law partner's RRSP until the end of the year in which the spouse turns 71, assuming the contributor has remaining RRSP contribution room.

The amount you can contribute each year is based on your annual contribution room, which is calculated annually by the Canadian Revenue Agency (CRA). Keep in mind that RRSP contribution room is based on certain types of earned income as defined in the Income Tax Act. Tax filers receive information about their contribution room on their annual Notice of Assessment from the CRA.

The following factors can affect the amount of your contribution room:

• Your “earned income” from the previous year, including net income from employment (such as salaries, bonuses, tips and gratuities), self-employment, business partnership and net rental income from real estate
• Spousal support received
• Royalties
• Your unused contribution room from previous years, which can be carried forward indefinitely
• Any pension adjustments (e.g., employer pension plan contributions)
• The maximum contribution limit set annually by the federal government

*You should note that most forms of passive investment income, such as capital gains, interest and dividends, are not included in the definition of earned income.

Contribution limits

Generally speaking, if you have no unused contribution room and no pension adjustments, your contribution limit will be the lesser of:

• 18% of your annual earned income, or
• The maximum limit set by the government ($27,830 for 2021; $29,210 for 2022; increasing to $30,780 in 2023).

More on contribution rooms

Understanding how your contribution room works from year to year is an important factor in making the most of your RRSP. To help you better understand, let’s consider an example. If you make $100,000 in 2022, and you are only able to contribute 16% of your income, your contribution would be $16,000. Because $16,000 is less than 18% of your annual earned income and also less than the maximum limit set by the government ($29,210 for 2022), that unused contribution amount ($29,210 - $16,000 = $13,210) be carried forward indefinitely until you are able to afford to make that contribution.  This allows you to catch up on your investments if you initially contributed below your set limit.

Tax implications of withdrawing funds from an RRSP

You can withdraw funds at any age and time, but there are immediate withholding and registration fees plus applicable taxes associated with all withdrawals. Thus, if you need to withdraw a certain amount, remember to add in the extra you will lose immediately in fees and taxes – keeping in mind, the taxes can be steep.

Additionally, withdrawals will subsequently be counted as income and will be taxed at your marginal rate for the year. Sometimes, you will owe an additional amount because the amount that was withheld is not enough to fulfill your tax obligation based on your tax bracket.

You should also remember that once funds are withdrawn, the RRSP contribution room does not regenerate – the room is lost forever. You can’t go back and recontribute that same amount later unless you meet a qualified exception.

Qualified exceptions – home purchases, education goals and helping disabled family members

While RRSPs are a long-term retirement savings vehicle, they do offer some flexibility to help achieve other financial goals in the right circumstances. Take note, if you choose to participate in the programs mentioned below, you will not be required to pay tax on withdrawn funds – unless you don’t repay them.

The Home Buyers’ Plan (HBP) allows you to withdraw up to $35,000 from your RRSP to buy or build a qualifying home for yourself or for a related person with a disability. The HBP allows you to take up to 15 years making equal payments during that time to pay back the withdrawn funds, with repayments starting the second year after the first withdrawal.

Similarly, the Lifelong Learning Plan (LL) allows you to withdraw up to $10,000 in a calendar year to a total LLP limit of $20,000. The LLP funds can be used toward any purpose, provided you (or your spouse or common-law partner) meet the LLP conditions when you make the withdrawal. You must repay equal amounts withdrawn over a 10-year period, starting the fifth year after the first withdrawal.

Both the HBP and LLP limits are personal to the individual, meaning partners or spouses can each withdraw the maximum and use the total funds toward a common home or education goal.

A word of caution: you should be aware that your RRSP deduction for the year may be affected negatively if you participate in either of these programs. Funds withdrawn for either HBP or LLP within 90 days of being contributed to the RRSP cannot be deducted from income for the year. This can be extremely complicated and confusing, which is another good reason to work with an Edward Jones financial advisor to help you navigate these nuances.

In addition to permitting funds withdrawn under the HBP to be used to buy or build a qualifying home for a related person with a disability (even if you don't qualify as a "first time home buyer"), the Income Tax Act also allows for a rollover of a deceased individual's RRSP to the Registered Disability Savings Plan (RDSP) of a financially dependent (due to physical or mental disability) child or grandchild.

Withdrawing from an RRSP after it matures

You must do one of the following when your RRSP matures:

• Withdraw the funds, include them in your annual income and close the account
• Transfer them to a Registered Retirement Income Fund (RRIF)
• Buy an annuity

An Edward Jones financial advisor can work with you to help you find the choice right for you.

Beyond the basics

Above, we’ve covered the basics. But there are many other things to consider when it comes to RRSPs. Let’s explore some of the lesser known aspects – beyond the basics – that are equally important for investors to understand.

Investments your RRSP can hold

People mistakenly believe that RRSP accounts can only hold Guaranteed Investment Certificates (GICs), mutual funds or Exchange Traded Funds (ETFs). While those may indeed be the best approach for one individual, others may benefit from including a mix of stocks and bonds in their RRSP account. However, there are limits to the types of investments that may be held in these and other types of registered accounts. Investments must meet the definition of “qualified investments”; a term that is defined in the Income Tax Act. Ineligible investments (like commodity futures) held in an RRSP may attract significant negative tax consequences (including a 50% tax on the value of the prohibited investment); so, you will want to make sure you work with your Edward Jones financial advisor to ensure your investments qualify.

Deductions

Text: You don’t need to claim the deduction in the same year you make the contribution. This is one of those little-known facts that can have a big impact on your bottom line. Just because you contribute to your RRSP for the benefits of tax deferral on the underlying investments, doesn’t mean you need to claim this deduction against your income for the same tax year.

You may choose to hold onto this deduction amount (all or some) for use in a future year. This could result in significant savings if, for example, you knew you would have higher taxable income in an upcoming year. There is no time limit for how long you can carry forward the allowable deduction.

Contributing to a spouse or common-law partner’s RRSP after you turn 71

You and your spouse/common-law partner can still make contributions to your spouse’s or common-law partner’s spousal RRSP until the end of the year in which your spouse turns 71, assuming the contributor has unused RRSP contribution room available. This provides a planning opportunity for an individual who carries over contribution room or continues to accumulate it by accruing earned income after age 71 and has a younger spouse or common-law partner. It could, for example, mean the contributing spouse is subject to reduced Old Age Security (OAS) clawback (or pension recovery tax) while providing tax-advantaged savings opportunities for the recipient spouse. This is a significant planning opportunity that is often overlooked. (The OAS clawback is $79,045 from July 2021 to June 2022 and $79,845 for July 2022 to June 2023.)

Qualifying for other benefits via RRSP contributions

RRSP contributions can make the difference in qualifying for other benefits. It’s worth a careful look at the details to see whether an increase in your contribution could mean you qualify for income-tested benefits you may be on the cusp of receiving. For example, a reduced net income (as a result of RRSP contribution and deduction against your income) could lead to increased refundable tax credits, like the goods and services tax/harmonized sales tax (GST/HST) credit, or increased income-tested benefits like the Canada Child Benefit.

Tax bill on death

Your tax bill on death can be the biggest tax bill you’ve ever paid. Many people include the full value of their RRSPs when they think about what their estate would look like if they were to prematurely pass away. In fact, the full value of your RRSP would be included in income in your year of death and taxed at what may be the highest marginal rate to which you’ve ever been subject. For example, assuming you had no other taxable assets, a $200,000 RRSP would be subject to an average tax rate of more than 30% and hit a marginal tax rate of nearly 50% in some provinces. There are tax deferral opportunities for spouses and children or grandchildren who are financially dependent due to disability; however, there are pitfalls that the unwary may fall into without the guidance of a professional financial advisor.

Withdrawals that make sense before retirement

Sometimes it makes sense to make RRSP withdrawals before retirement. Most individuals just forget about their RRSPs until retirement because they think it’s locked- in or assume massive tax liabilities. The reality is that there are many times where it may make sense to withdraw funds from an RRSP. For example, if you’re in a year of low relative net income and have an urgent need for additional funds because of maternity or paternity leave or unemployment, accessing your RRSP may be the best of the available options.

It may also make sense to begin a drawdown strategy in the years leading up to retirement. If you anticipate you’ll be in a high tax bracket in retirement, drawing down on your RRSPs early may reduce the likelihood of OAS clawback or help keep the marginal rate lower over the long term. Taking a careful look at all the details is critical in these situations.

We can help

There’s much more than meets the eye when it comes to RRSPs. Your Edward Jones financial advisor can help build your understanding of RRSPs and assist you in determining the RRSP strategy right for you.