Not Every Canadian Needs an RRSP? Find Out Here If an RRSP Suits You!
Tuesday, December 12, 2023
Not Every Canadian Needs an RRSP? Find Out Here If an RRSP Suits You!
Tuesday, December 12, 2023
Mitch Zaba
Tax planning is one of the critical steps when determining what to invest in, and which tax vehicle will be most efficient to reach your objectives. We sometimes forget that taxes are one of the largest expenses in our working life, and retirement. Reducing the amount of taxes you pay can be equally and sometimes more important than your investment returns. Only when you pair tax efficiency with consistent investment returns, will your portfolio be fully optimized.
Your situation will dictate which tax vehicle applies most to you. The most important factors to consider are:
- Your annual income
- Future pension income
- Type of income, salary or dividend
- Your emergency savings
The most common ways of being tax efficient are proper implementation of the Tax-Free Savings Account (TFSA) and Registered Retirement Savings Plan (RRSP).
Registered Retirement Savings Plan (RRSP)
An RRSP is one of the most common savings accounts for retirement savings. An RRSP is a federally registered account that comes with certain tax advantages.
- Contributions are tax-deductible - When you contribute to an RRSP, you can deduct your contribution from your earned income for that year.
- Earnings are tax-deferred - Investment earnings are tax-deferred allowing increased compound growth. You pay taxes when you withdraw the money from your RRSP account.
There are limits to how much you can contribute to an RRSP. You can contribute 18% of your earned income to a maximum of $30,780 for 2023. You can carry forward your contribution and catch up years when you couldn’t contribute the maximum.
RRSPs are an excellent strategy when you expect your marginal tax rate to be lower in retirement or if your employer does not provide a pension plan. With the implementation of the TFSA in 2009, you must consider both options for your situation.
What can you invest in your RRSP?
You can invest the following in your RRSP:
- Cash
- Gold and silver bars
- GICs
- Savings bonds
- Treasury bills (T-bills)
- Bonds (including government bonds, corporate bonds and strip bonds)
- Mutual funds (only RRSP-eligible ones)
- ETFs
- Equities (both Canadian and foreign stocks)
- Canadian mortgages
- Mortgage-backed securities, and
- Income trusts
Spousal RRSP
In situations where one spouse makes significantly more than the other, it may make sense to set up a Spousal RRSP. With a Spousal RRSP, the contributor receives the tax deduction and the owner (recipient of the spouse) can withdraw the money in his or her name in retirement. Be aware of attribution rules when using a Spousal RRSP.
RRSP Withdrawal Rules in Canada
RRSPs are an effective savings vehicle for retirement. However, they aren't useful when you’re in a financial pinch and you need money. Before you make an RRSP withdrawal, here is what you need to know.
Before you make an RRSP withdrawal, exhaust all other options for getting money. We find that it is cheaper to get a secured line of credit from your bank, a term loan, or make a withdrawal from your TFSA.
If none of these options are available to you then consider your options below.
Important Considerations of an RRSP Withdrawal
- Taxes - When you make a withdrawal from your RRSP, you have to claim the entire withdrawal amount as income in the year you make the withdrawal. For working individuals, this can put you into higher tax brackets and get very expensive.
- Contribution Room - You do not get your RRSP contribution room back after making an RRSP withdrawal.
- Withdrawal Fees - Some institutions charge fees for redeeming your money. This can come in the form of an administration fee, a deferred sales charge fee, or a transaction fee commonly found in stock portfolios.
- Compounding Interest - When you take money out of an RRSP plan, you lose the benefits of compounding growth on that money. This is a double penalty. Not only will you pay taxes, you also reduce the amount of compound growth you can earn.
Taxes on RRSP Withdrawals
When making an RRSP withdrawal, you have to factor in two types of taxes. The first is a withholding tax and the second is your marginal tax rate.
Withholding taxes are taxes withheld by your financial institution where your RRSP is held. These taxes are then forwarded to CRA on your behalf. This is meant to provide a layer of protection for investors so that you are not surprised by a large tax liability when you file your annual tax return.
Your marginal tax rate is your combined provincial and federal tax rate. You can see and calculate your tax rates here.
In many cases, the withholding tax rates are lower than your tax rate which will create a tax liability when you file your taxes. This is especially true for individuals still working who make an RRSP withdrawal.
RRSP Withholding Tax Rates
The RRSP withholding tax rates for Saskatchewan, all provinces (except Quebec) and territories are as follows:
- 10% on amounts less than $5,000
- 20% on amounts of $5,001- $15,000
- 30% on amounts greater than $15,000
When you make an RRSP withdrawal, you will have to declare if you want to make a net amount or gross amount withdrawal.
Net amount withdrawals are the net amount of money after withholding taxes. If you request a $10,000 net withdrawal, your institution will add a 20% withholding tax to the withdrawal. The total amount withdrawn from your RRSP account will be $12,500. Calculated as $10,000 divided by (1 minus 20%).
Gross amount withdrawals are the total amount withdrawn from your RRSP account. If you request a $10,000 gross withdrawal, your financial institution will withhold 20% in taxes for CRA and $8,000 will be deposited into your account. Calculated as $10,000 minus ($10,000 x .20%)
Spousal RRSP Withdrawals
Spousal RRSPs are a hidden gem when tax planning for married and common-law couples. However, Spousal RRSP withdrawals need to consider attribution rules. Spousal RRSP places a 3-year attribution rule on withdrawals for the account owner and contributor.
If you’re considering a Spousal RRSP withdrawal in 2023, your contributor must not have contributed to any Spousal RRSP account in your name in 2022 or 2021.
Example 1:
I want to make a withdrawal from a Spousal RRSP account in my name that my wife contributed to in 2022. Because I did not wait 3 years, this money is “attributed” back to my wife and she will have to claim it as income based on her tax rates.
Example 2:
I want to make a withdrawal from a Spousal RRSP account in my name that my wife made her last contribution to in 2017. Because she didn’t make any contributions this year and the two previous years, I will claim the RRSP withdrawal as income in my name and pay taxes based on my tax rates.
Remember, the attribution rules are based on the last contribution date, period. That means even if you skip years or have contributed for 20 years straight, to avoid attribution rules, you still have to wait 3 years for any withdrawal.
Example 3:
I want to make a withdrawal from a Spousal RRSP that my wife made contributions to in 2012 and 2020. I cannot designate to withdraw the 2012 contribution amount. I must wait until 2024 to avoid attribution rules.
Withdrawals from a Spousal RRIF
Attribution rules still apply for withdrawals from a Spousal RRIF with one exception. You can withdraw the RRIF minimum amounts without attributing any tax to the contributor.
Mandatory RRSP Withdrawals At Maturity
At age 71, you must close your RRSP accounts. There are several ways you can do this:
- Convert Your RRSP to a RRIF - A RRIF (Register Retirement Income Fund) is the income drawing version of an RRSP. Converting your RRSP to a RRIF is the most common option as you will use this money for income for the remainder of your retirement.
- Purchase an Annuity - You can purchase a registered annuity from an insurance company.
- Withdraw the Money - The most expensive option is to withdraw all of your RRSP money. Many Canadians retire with several hundred thousand dollars in their RRSPs and withdrawing 100% of them would mean paying up to 50% in tax on the money.
Tax-Deferred RRSP Programs
Two government programs allow you to withdraw RRSP money as a loan to yourself. This money has to be paid back or you will be required to pay taxes on the withdrawal amount.
Home Buyers’ RRSP Plan
The Home Buyers’ Plan is for first-time home buyers. You can withdraw up to $35,000 from your RRSP for a down payment on your house. If your spouse or common-law partner is also a first-time home buyer, they too can withdraw up to $35,000 from their RRSP. That allows a healthy $70,000 down payment toward your new home.
Check out the full HBP details on the CRA website for eligibility and repayment rules.
*Note: With the introduction of the First Home Savings Account, the Home Buyer's RRSP plan is now the second best option. Consider using the First Home Savings Account before the Home Buyer's RRSP plan.
Lifelong Learning Program
The second tax-deferred program is the Lifelong Learning Plan. This program allows you to withdraw up to $10,000 per year for you or your spouse to help pay for education or training. The maximum amount you can withdraw from your RRSPs in this plan is $20,000.
Click on this link for more information on the Lifelong Learning Program.
Frequently Asked Questions
- When can you withdraw from your RRSP?
- There are no limitations on when you can withdraw from your RRSP. You will have to claim any withdrawal as income in the year you make the withdrawal. - Is there a limit to how much you can withdraw?
- No. You can withdraw 100% of your RRSP account(s) at any time. You will have to pay tax on the entire withdrawal in the year you make the withdrawal. This will be very expensive - How will an RRSP withdrawal affect my taxes?
- You must claim any RRSP withdrawals as income for the current tax year. You will be taxed at your marginal tax rate
Who are RRSPs best suited for?
Buying an RRSP is not a one size fits all approach, especially since the introduction of the TFSA.
RRSPs are best suited for:
- High-Income earners: If you are in a high tax bracket and you expect to be in a lower tax bracket in retirement. For example, You're making $135,000 and paying a 38.% marginal tax rate. If you expect your income to drop below the next federal tax bracket at $106,717, you will immediately save 5.5% on taxes alone.
- Married or common-law partners: Take advantage of the Spousal RRSP and transfer future tax liabilities to a lower-income earning spouse. See above.
- Have a long-term investment horizon: Because RRSPs are designed for retirement savings, they tend to have a long investment horizon. This makes them well-suited for those who are saving for retirement, but not necessarily for shorter-term goals.
- Year of death: The legal representative of a deceased annuitant can't make a final contribution to the deceased's RRSP after their passing. However, if the deceased's RRSP has contribution room available, their surviving spouse can make a contribution to their own RRSP, provided they are 71 years old or younger. This can be done either in the year of the annuitant's death or within the first 60 days of the following year.
Do not invest in RRSPs when:
- You don't have emergency funds available: Since you have to pay taxes on RRSP withdrawals, this account isn't suitable for emergency savings or if you don't have other sources of money to use when emergencies come up.
- You're not in a high tax bracket: How do you know if you're in a high tax bracket? I use the federal tax bracket threshold of 26%. If your income is below the 26% tax bracket ($106,717) then the TFSA is a better choice.
Conclusion
RRSPs are a great way to save for retirement and can offer significant tax savings. They are best suited for high-income earners, married and common-law partners, those with a long-term investment horizon, and those in the year of death of an annuitant. However, they should not be used as emergency funds or if you’re not in a high tax bracket. Be sure to check out the CRA website for more information on eligibility and repayment rules before making your decision. Ultimately, it is important to consider all factors before investing in an RRSP to ensure that you get the most benefit from your investments.
Hi, I Am Mitch Zaba
Over the past 10+ years, we've worked closely with clients showing them how to grow their wealth, pay less taxes and how to create predictable passive income in the stock market.
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