Everything you need to know about RRSPs
If you are like most Canadians, chances are you could use some help when it comes to saving for your retirement. When used to its full advantage, a Registered Retirement Savings Plan (RRSP) can be a powerful tool that can save you money on your annual tax return while helping your savings grow. RRSPs can work well if you contribute while you are in a high tax bracket (while you are working) and withdraw when in a lower tax bracket (when you are retired). For low income Canadians a Tax-Free Savings Account (TFSA) may be more beneficial.
What is an RRSP?
An RRSP is a retirement account that is registered with the Canada Revenue Agency (CRA) and that you or your spouse make contributions to. Because deductible contributions can be used to reduce your tax and because income or growth earned in the plan is usually exempt from tax while the funds remain in the plan, an RRSP acts like a tax shelter that provides you with a powerful incentive to save money for your retirement years. You can open an RRSP at many financial institutions including: banks, trust companies, mutual fund companies and stock brokerage firms. An RRSP is designed to hold a number of qualified investments such as stocks, bonds, and other popular securities including mutual funds, segregated fund contracts and GICs.
RRSP contribution room is generally available to you if you have earned income. Once you contribute funds into an RRSP, any growth or income earned on the underlying investment will not be taxed until you withdraw that money. In addition, you can claim tax deductions for contributions you make to your RRSP. Since you received a tax deduction when you contributed funds to the RRSP and the funds accumulated on a tax-free basis, when withdrawing those funds prior to the plan’s maturity, it will be regarded as taxable income by the government and will be subject to tax in the calendar year you receive it.When you hold the RRSP until the plan matures, the money you’ve saved can be withdrawn as a lump sum. But if you decide to go this route, the money you withdraw will be regarded as income and taxed in the calendar year you receive it. This could trigger a large tax bill. There are alternatives, however. By using your accumulated savings to purchase a retirement annuity or open a Registered Retirement Income Fund (RRIF), you are able to delay the receipt of your funds, and consequently, continue to defer paying tax on the savings remaining in the plan.
Why should I contribute to an RRSP?
There are two important reasons why you would want to make regular contributions to an RRSP:
1. To lower the amount of tax you pay now
2. To provide financial security for you and your family during retirement
When and how much can I contribute?
You can contribute to an RRSP at any time. However, for contributions to be tax-deductible for any given year, they must be made on or before the 60th day of the next calendar year. This date typically falls on or about March 1st.
In any given calendar year, your RRSP contribution limit is equal to:
1. Any unused RRSP deduction room left over from prior years.
2. Plus the lesser of 18% of your earned income for the prior year or the RRSP dollar limit for the current year.
3.Minus the pension adjustment reported on your prior year’s T4.
4. Minus any past service pension Adjustments
5. Plus any Pension Adjustment Reversal reported.
Remember that the earned income used in this calculation is for the prior calendar year, not the current calendar year. This allows you to calculate your RRSP deduction limit in advance.
How long can I contribute to my RRSP?
Because an RRSP is essentially a retirement savings vehicle, it has been designed to mature when you turn 71.When you turn 71, you must make your annual RRSP contribution by December 31st of that year. You must also collapse your RRSP by December 31st of that year. If you are over age 71, you may still contribute to your spouse’s RRSP – as long as your spouse is under age 71.Since age 71 marks the last year that you can make a contribution to your own RRSP, it is advantageous for you to make your last eligible contribution before you close your plan. If you have not claimed a deduction for all contributions made up to the end of the year in which you turned 71, you can still claim them in future years (i.e. there is no age limit for claiming a deduction as long as the contribution was made in or before the year you turned 71).
What happens to my RRSP when I retire?
Although your RRSP must mature before the end of the year in which you turn 71, you do not have to wait until then to withdraw income from your RRSP. Most plans can mature at any time, allowing you to take early retirement, if you wish.
What are my options?
At maturity, all of your accumulated funds must be withdrawn from your RRSP. You can take a lump-sum payment, where you would pay tax at your marginal rate at the time of withdrawal. Perhaps a better alternative would be to purchase one, or a combination of RRSP maturity options. RRSP maturity options provide you with retirement income in varying amounts over varying periods of time. In addition, tax is deferred until you actually receive your retirement income, which allows more of your money to remain invested on a tax deferred basis over longer periods of time.
What happens to my RRSP when I die?
If you die before your RRSP has matured, the proceeds are paid out in a lump sum to either the beneficiary you named in the plan or to your estate.The general rule is that the deceased is taxed on the value of the registered plan on the date of death. However, there are circumstances where the tax can be deferred if the proceeds are transferred to a qualified individual.
Payments of proceeds to a spouse
You will not be considered to have received the RRSP proceeds on death if your spouse is named as beneficiary of your RRSP. For this to occur, your spouse must transfer the proceeds of the RRSP to an eligible registered plan or to an issuer to purchase a qualifying annuity. In this situation, your spouse will be taxed on the RRSP proceeds; however, your spouse will also receive a contribution receipt for the amount transferred into his/her registered plan or annuity. Payments from an RRSP to your estate for the benefit of your spouse are also taxable to your spouse, provided your spouse and the legal representatives of your estate file a joint tax election. If this election is not filed, the RRSP amounts will be included in your income for the year of death. To minimize legal, estate administration and probate7 fees, it is preferable to name your spouse as the beneficiary of the RRSP rather than to file the election after death.
Payments of proceeds to someone other than a spouse
If you want the proceeds of your RRSP to go to someone other than your spouse, generally, the proceeds from an RRSP must be included in your income in the year of death. An exception occurs when the beneficiary is a financially dependent child or grandchild less than 18 years old or a child or grandchild dependent by reason of physical or mental infirmity. Under these circumstances, it is possible to have all or a portion of the proceeds taxed in the hands of the child or grandchild and have the child receive a deduction for a transfer to an RRSP, RRIF, RDSP (Registered Disability Savings Plan), or annuity.
If you name a person other than your spouse or qualified dependent as beneficiary of your RRSP, your estate will be faced with paying the tax liability even though it may not have enough funds to do so because the entire proceeds of the RRSP were paid to the named beneficiary. If your estate has insufficient assets to meet such tax liability, the beneficiaries of the plan would be jointly liable for the taxes owed by your estate.
Spousal contributions after your death
In the year of your death, or within 60 days after the year-end, your legal representative may make a contribution to your spouse’s RRSP under the normal rules. This contribution will be deductible on your final tax return.