An RRSP stands for a Registered Retirement Savings Plan and has been around since 1957. This is a plan for individuals to save up for their retirement by giving them tax advantages. An RRSP is

- Registered with the Canadian federal government

- Legally recognized as a trust

- Offers tax benefits over regular investment accounts

- Can hold many different types of investments

The best time to contribute to an RRSP is the first 60 days of each year, known as RRSP season. During this time, any money that you put into an RRSP is eligible for a tax deduction for the previous year. However, there is a limit to how much money you can put into this savings plan. For example, if you put in $100,000 into your RRSP in the 60 days of RRSP season, you will only be able to claim tax benefits on a small portion of that so it’s better to make a limited contribution each year for a number of years instead of a large amount all at once. An RRSP can help you plan for your retirement, put money away on a consistent basis but it also has some drawbacks which we will look at near the end of this post.

The Basics of an RRSP

How Much Can You Put Into Your RRSP?

“18% of your previous year’s earned income less your previous year’s pension adjustment to an annual maximum.”

- Earned Income – earned income is different than your taxable income or net income for tax purposes.  Earned income includes employment salary (including taxable benefits), self employed income, rental and royalty income, taxable child and spousal support payments, research grants, CPP disability payments, employee profit sharing plans and supplementary unemployment benefits (not regular EI benefits)

- Pension Adjustment (PA) – The pension adjustment is used to ensure there is fairness between those that are part of a pension plan and those that are not part of a pension plan.  If you are members of a pension plan through work, you will be able to contribute less to an RRSP because of your pension contributions.  For defined contribution plans, the PA is simply the total of employee contributions and employer contributions.

- How much is the annual maximum? The maximum RRSP contribution limit is set every year by the government.  Here’s a list of RRSP contribution limits dating back to 2000 (thanks to Taxtips.ca for the data.

Source: http://groupbenefitsonline.ca/how-much-can-i-contribute-to-a-rrsp/

It is very important to stay within the limit of how much you can contribute to your RRSP each year. You are allowed to contribute up to $2000 more than your limit, but make sure you are careful; any more than that and you will be charged a penalty of 1% per month.

Who is Eligible for an RRSP?

Anyone can set up an RRSP, provided they are under the age of 69, file income tax with the Canadian government and has room to contribute.

What RRSP Should You Invest In?

There are many ways you can invest in RRSP’s which is why this is such a popular choice when it comes to thinking about your retirement; there is generally something for everyone. There are many choices on how to invest in your RRSP including through savings accounts, mutual funds, stocks, bonds, GICs, money markets, EFTs and more.

The best thing to do is to do your own research on what type of RRSP contribution would work best for you. Don’t just blindly believe whatever you hear; remember that your best interests are not always the main priority of others and you have to decide what will work best for you.

When Should You Start Investing in an RRSP?

As many financial advisors will tell you, you should begin investing in an RRSP as soon as possible, even as early as your first job. It is never too late to start thinking about your retirement plan and start planning for the future. If you take a look at some basic math, the earlier you start investing into your RRSP (as long as it is on a consistent basis), the less you’ll have to put in each week in order to reach your RRSP goal by the time you hit the retirement age of 65. If you start putting money away when you’re 40, you will have to put away much more each week in order to keep your goal of retiring at 65. For example, if you start saving at age 20, even if you just put $50 a week into your retirement savings, by the time you hit 40 you will already have $52,000 saved up. If you start putting money away at age 40, then you will have to catch up $52,000 on top of saving up for the last 25 years before you hit 65.

When it comes to investing in your future, it is always wiser to start looking into it sooner rather than later, whether you are investing in RRSP’s or in an entirely different retirement plan. However, it is more important to be educated about where you are putting your money; this means it is not only important to start early, but also to start looking around so you know what you’re getting yourself into as early as possible. There is no set age for when you should start thinking about your retirement, but the earlier you start planning it, the earlier it will happen. For those who do not plan their retirement early, it might not happen at all.

When Should You Take the Money Out of Your RRSP?

The money in your RRSP account is ideally supposed to be used for your retirement, however, you can also use it to purchase a new home or go back to school without having to pay any taxes. Should you want to withdraw your RRSP money for another purpose, taxes will be playing a big part so use this only as a last resort.

If you’re still thinking about taking money out of an RRSP early, consider this: once you’ve taken money out of an RRSP through an early withdrawal, you’ll never be able to recontribute that amount. For example, let’s say that your lifetime contributions to your RRSP total $15,000. Because you have not always made the maximum allowable contribution, you have also accumulated $30,000 in additional contribution room. If you withdraw the $15,000 and want to re-contribute that $15,000 at a later date, the re-contribution will reduce your $30,000 unused contribution room down to $15,000.

Read more: http://www.investopedia.com/university/rrsp/rrsp7.asp#ixzz1bZDIP346

As you can see, taking your RRSP money out early can be quite expensive. However, if you want to use your Registered Retirement Savings Plan to go back to school, you can take out up to $25,000 for a down payment as part of the Home Buyer’s Plan (HBP). Once you take this money out of your RRSP, you have 15 years to repay it or the opportunity to recontribute will be lost.

You can also take up to $20,000 out in order to go back to school, but only at $10,000 per year. This is known as the RRSP Lifelong Learning Plan (LLP). Once you take this money out and use it for a post-secondary education, the repayment process doesn’t begin until 5 years afterwards and once the repayment begins, you will have 10 years to recontribute what you have withdrawn or the opportunity to replace these funds will be lost entirely.

RRSP Benefits

The biggest benefits to having an RRSP are the tax benefits. The first tax benefit is called tax-deferred growth which basically means that any profit you have made on your RRSP, whether it is in the form of interest, capital gains etc, will not be taxed on until the money is withdrawn from your account. This is a benefit because by the time you retire, you’ll most likely have a lower income than in your prime earning years and therefore will be taxed less.

The other tax benefit is in the form of a tax credit. This means that whatever money you contribute to your RRSP during the course of the year, you will not have to pay taxes on in the following year when you file your income tax return. For example, if you make $50,000 and you put away $10,000 into your RRSP, you will only have to pay taxes on the $40,000 as a result. This is known as a tax credit and can be a huge advantage to some.

By having an RRSP, you know exactly how much money you have in your retirement plan, how much more money you need before you are able to retire and you can even use it earlier on for school or to buy a new home. Another benefit is that this is a very well-known investment plan which most workplaces embrace and as a result you can have part of your pay check automatically deducted (and in some workplaces, matched) to help you save money even faster.

RRSP Drawbacks

One of the drawbacks of investing in an RRSP is that once the RRSP is cashed in, the capital gains will be taxed at the regular higher rate, not the lower capital gains tax rate. Another thing about RRSPs that I personally find a huge drawback is that there is no protection against inflation in the economy. What ends up happening is that individuals start saving money early on, contribute as much as they can from their pay check into their retirement fund and then later down the road when it’s time for them to retire, they notice that their purchasing power has gone way down due to inflation and they can now buy less than half the things that they could have purchased 20 or 30 years ago. As a result, they end up retiring with much less money than they had hoped and most likely have to go back to work in order to fill in the gap.

When I invest in the long term, I personally like to invest in something with a little more stability in the future; something that will bring me more money and become even more valuable as time goes on instead of less valuable. I do highly recommend that you look into RRSPs and other retirement investment opportunities (and don’t be afraid to get creative – this is how most people make high returns on their investments) before you end up making a decision about what retirement plan is right for you. There are many different options out there so be sure to educate yourself before putting your money down.

Helpful RRSP Tips

The first you should do before you get an RRSP is to do some research on it. Just because it works for some people does not mean it will fit for everyone. Many people are talking about how you should invest in RRSP’s, but there are many other different retirement investments which are worth looking into. Retirement plans are not a “one size fits all” type of plan. Depending on how much risk you want to take, how much return you want on your investment and how much time you have to play around with this, RRSP’s may not be the right investment for you. That being said, for many people it is the perfect investment.

Once you do your own research and should you decide that an RRSP is the right investment for you, the next thing you should do is to set up your RRSP in a way which will enable you to contribute to it on a regular basis. Most people accomplish this by setting it up automatically through their bank; other people have an RRSP contribution at their work. It’s been found that if you set up your RRSP so you contribute often (even if it’s just a little bit), you will be much more successful over the long run than those who contribute rarely (especially if it is not automatic).

If you are contributing to an RRSP through a work plan, make sure you very carefully read the contract before signing it; many workplaces have loopholes in their RRSP plans that you might not be comfortable with so be sure to read everything very carefully and ask questions before agreeing to anything. For example, many workplaces choose the type of RRSP you will be contributing (such as a particular stock or mutual fund) that you might not want to put your money into. Even if they offer you a matched rate, be sure to read between the lines to see if there are any catches that come with it.

The last RRSP tip I would like to mention is to start early and stick with it. Your RRSP will not increase unless you keep contributing to it on a regular basis. The key is to set up an amount of money per pay check that you can live without and stick with it. After a while you won’t even notice the money coming out of your account anymore.

The image used in this post was taken from Image: Ambro / FreeDigitalPhotos.net

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