A Registered Retirement Savings Plan (RRSP) is a type of financial account that is registered with the Canadian federal government. It offers tax advantages to individuals who contribute and provides you with a safety net after retirement. In Canada, you can open an RRSP through a financial institution like a bank, credit union, or trust company.
It’s important to understand the rules before making contributions, to avoid penalties. For excess contributions exceeding the RRSP deduction limit by $2,000, you will have to pay 1% tax every month for that excess. You can avoid this by withdrawing the excess amount or transferring it to a qualifying group plan.
RRSP accounts can hold different investments such as; Cash, bonds, stocks, mutual funds, ETFs, options, treasury bills and guaranteed investment certificates (GICs).
The contribution you make to your RRSP is based on a percentage of your earned income, plus previously unused contribution room less any pension adjustments. Your maximum RRSP contribution limit is 18% of your annual earned income or $27,880 (whichever is lower) from the previous year.
Contributions areĀ tax-deductibleĀ in the year they are made. This means that when you contribute to an RRSP, you are reducing your taxable income for the year by the amount of your contribution. For example, if you earn $90,000 in 2022 and contribute $10,000 to your RRSP, then your 2022 income would be taxed as if you only earned $80,000.Ā
Additionally, contributions made to an RRSP areĀ tax-deferredĀ and will be taxed on withdrawal at the marginal tax rate. In simpler terms, the underlying investment income earned within an RRSP is sheltered from taxes until funds are withdrawn (interest earned on GICs, dividends paid on stocks, or any investment gains held within an RRSP, are not taxed until withdrawn).
You can invest in an RRSP until December 31 the year you turn 71. After this date, you can contribute up to your RRSP deduction limit to aĀ spousal RRSP or common-law partner RRSPĀ if your spouse or common-law partner is 71 or younger.
At the start of every year, youāre allowed to make contributions to your RRSP during the first 60 days and claim it as a deduction in your income tax return for the previous year. For people who haven’t used their contributions from previous years, there is more room for contribution.
The contributed amount will be deducted from your taxable income, thus reducing your taxes owing in any given year. Because your contributions are tax-deductible, you may receive a tax refund every time you make an RRSP contribution. The refund can be as much as 50% of every dollar contributed, depending on your personal tax rate.
You can also use an RRSP to split income with your spouse or common-law partner. For example, if one spouse or common-law partner has a significantly higher income than the other, he or she may be able to contribute to an RRSP for the other and deduct that amount from his or her income. (Note: Contributions to your own plan and your partners canāt exceed your allowable maximum contribution.)
To learn more about other registered accounts, such as a tax-free savings account (TFSA), click here.
Kenyon Ndezi is a recent graduate, writer, creator of vividbay.com, and the owner of Neonbuild.com, which is a company focused on building apps for small businesses and individuals. Follow along and get inspired!
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