Should you open a RRSP account ? An introduction

RRSP Basics?

Registered Retirement Savings Plans (RRSPs) are government registered accounts for individuals to build towards their retirement. Contributions within the RRSP accounts help account holders lower their taxable income in the year of the contribution. Growth within the RRSP account is tax sheltered. If account holders withdraw the money at retirement, they would be subject to a lower tax rate.

Example of some RRSP account types

Three primary RRSP types:

• Individual RRSP: This account type, investments within the account and tax advantages belong to the contributor.

• Spousal RRSP: This account and investments are held by your spouse or common-law partner. You’re able to contribute to the investments held by your spouse and claim the tax deductions. Your contribution does not impact your spouse’s contribution limit. This approach can be beneficial if one partner makes significantly more income. The higher income earner can benefit from the tax deduction. Withdrawals in retirement are taxed under the lower income earner.

• Group RRSP: This account is held by you, but your contributions go through your employer. The amount is deducted from your pay cheque. Your employer may then match or exceed your contribution. The great thing about this account type is that both your and the employer’s contributions are tax deductible to you. A limitation is that you likely won’t have a lot of investment options available.  

Why should you open a RRSP account ?

• It’s a tax-Sheltered account -> Capital gains, dividends, interest income from bonds etc. (any investment income) within the RRSP account will not taxed until the money is in the account. The tax rate applicable as already mentioned will at the time of withdrawal. Keep it compounding!

• RRSPs help with tax savings -> RRSP contributions can help reduce the tax owed amount. You can use one of the many free RRSP calculators available online to gauge the potential of your taxes through RRSCP contributions. The following numbers are from using the calculator on https://turbotax.intuit.ca/tax-resources/canada-rrsp-calculator.jsp for an income of $80,000 with varying RRSP annual contributions in Ontario:

RRSP contribution category	Employment Income	Income taxes owed	RRSP contribution	Estimated tax owed
None	$80,000	$16,273	$0	$16,273
Case 1 (5%)	$80,000	$16,273	$4,000	$15,087
Case 2 (9%)	$80,000	$16,273	$7,200	$14,115
Max (18%)	$80,000	$16,273	$14,400	$11,853

Note that this example assumes you also made $80,000 the year prior as the maximum annual contribution to an RRSP account is 18% of the gross (pre-tax) income the year prior. Note that the annual limit for 2021 was $27,830.

You, of-course, must pay taxes whenever you take the money out from your RRSP account. But deferring withdrawals this until your retirement will help you withdraw the money at a much lower rate compared to your prime working/earning years.

• RRSPs can help with the purchase of your first home -> You can borrow up-to $35,000 from your RRSP account for the purchase of your first home. Using the example above, someone with an income of $80,000 contributing 4K annually for 5 years would be able to withdraw $20,000 from their RRSP account at the end of 5 years. In this process, they would be able to realize upwards of $1.2K on tax savings each year alongside the ability to access this amount. The borrower will need to, however, put the funds back withdrawn back into their RRSP over the next 15 years to continue enjoying tax savings.

Where can I find my current year RRSP deduction limit ?

On your CRA account.

When should you open (and contribute to) a RRSP account ?

Definitely not a one-size fits all answer here. The amount and the pace of the contributions can be highly individualized based on one’s age.

A logical personal finance strategy would be to first become debt free. Cut down on all debt especially high interest debt including but not limited to student debt and other non-mortgage debt. Once this is done, one could consider investing some money in a Tax-Free Savings account with the intention to build up reserve funds for emergency.

Many millennials pay down their student debt in their 20s and investing in RRSPs may not be a possibility then. An excellent thing about RRSP deduction limits is that they are carried forward. So even if one hasn’t contributed in their 20s, they have a chance to do so in their 30s and beyond. This is not a bad situation to be in as employment income can increase with increase in experience.