A Registered Retirement Savings Plan (RRSP) is a specific type of account intended to help Canadians save for retirement. Unlike a regular investment account, the earnings in an RRSP are not subject to income tax until the funds are withdrawn. Contributions made to the account easily compound with the gains to increase your savings, virtually without external conditions. This is the most significant advantage of an RRSP.
A common misconception associated with this retirement savings vehicle is that it is itself an investment. This is incorrect. Maybe you’ve heard somebody talk about the RRSP they bought or are planning to buy. But you cannot actually purchase an RRSP. Rather, you open one. It is the specific investments that you hold inside your RRSP account that you buy and contribute to.
RRSP accounts are not usually locked. However, that doesn’t give you the go-ahead to withdraw funds from it, even if it is to handle life’s little necessities or challenges. In fact, withdrawing money from an RRSP “costs” you the contribution room you used when you made your original deposit. Even if you make future contributions, you won’t be allowed to recontribute the funds you withdrew.
These are some of the features of a Registered Retirement Savings Plan:
- It is recognized as a trust in legal terms.
- Registration happens with the federal government.
- It offers more tax benefits than a regular investment account.
- It can hold many different types of investments.
Here are five benefits of making a contribution to your RRSP:
1. Tax Deferral
To echo what was said earlier, every contribution you make to your RRSP is a chance to defer or minimize tax. Most people are in a higher income tax bracket during their time working than when they are retired. RRSP contributions are deductible for income tax purposes, so the deduction can mean that your working income is taxed at a lower rate. Because your income may be lower, and therefore taxed at a lower rate, in the future than it is now, you will also likely pay less income tax on funds withdrawn from the plan during retirement.
2. Spousal RRSP Contributions
The government allows you to contribute to your spouse’s RRSP account, making it possible for the contributing spouse to receive a tax deduction while increasing the investments in their spouse’s RRSP.
Spousal contributions prove most useful in situations where spouses earn quite different incomes; that is, one earns much more than the other. The contributing spouse’s high tax rate can be reduced, and when the funds are withdrawn in retirement by the lower-earning spouse, they will be taxed at a lower rate.
3. Home Buyer’s Plan
Contributing to an RRSP is a long-term strategy. So it may be difficult to focus on it when you’ve got short-term targets, such as purchasing a house, that you also want to meet. But an RRSP makes investing in your future possible while still helping you meet your immediate goals.
Thanks to the RRSP Home Buyer’s Plan, you can withdraw up to $25,000 – once – to buy a home. Withdrawing the money does not attract any income tax, but you must recontribute the funds to the retirement plan within 15 years.
4. Lifelong Learning Plan
The Lifelong Learning Plan can come in handy if you or your spouse decide to extend your education. The plan gives you a chance to withdraw up to $10,000 for full-time learning, with a lifetime withdrawal limit of $20,000. The Lifelong Learning Plan cannot be used for your children, however.
5. Tax-deferred Growth of Contributions
Making an RRSP contribution shields the growth of your money from income tax. Although the government will tax any withdrawals from your account in the future, you don’t have to report to them any investment transactions. Your money receives uninterrupted growth!
Whether or not you contribute to an RRSP depends on your specific situation, but you should be aware of the financial challenges that can come with retirement and how important it is to prepare yourself. Open an RRSP and reap its benefits as you get ready for your future.