1. Nature of an RRSP
Purpose – The RRSP is designed to assist with long-term savings, generally funding toward your retirement years. Being ‘registered’ with the Canada Revenue Agency (CRA), it is entitled to beneficial tax treatment, while having to comply with stringent rules governing its ongoing use and operation. As the owner of the RRSP, you are known as the annuitant.
Investment options – Qualified investments for RRSPs include money accounts, deposits with a regulated financial institution and guaranteed investment certificates; stocks, bonds and most other securities listed on a designated stock exchange; and mutual funds and segregated funds.
Key tax features – Contributions to an RRSP are deductible in calculating current income. Income and growth within the RRSP are not taxed. Withdrawals are taxable in the year taken. This defers tax and facilitates lower ultimate tax if the annuitant is at a lower tax rate in future.
2. Funding your RRSP
Contribution limits – A person is entitled to annual contribution room equal to 18% of the previous year’s earned income, limited to an annually indexed dollar maximum. For your 2019 tax return, the dollar limit is 18% of 2018 income, to a maximum of $26,500, which would be reached at income of $147,222.
Spousal plan – If you have a spouse or common law partner (CLP), you may contribute to a spousal RRSP. You will get a current deduction, and the eventual withdrawal will be taxable to your spouse/CLP. However, if a withdrawal is made the same year or the next two years, the income will be attributed to you. Otherwise this can be an effective income splitting strategy.
Timelines – In order to claim the deduction, generally a contribution must be made in the calendar year, or within 60 days of the year-end. To qualify for deduction against 2019 income, the contribution deadline is Monday March 2, 2020.
Unused room – If you do not make a contribution, your unused room is carried forward for you to use in future years. In fact, even if you make a contribution, you can either claim the deduction in that year or carry the deduction forward to claim against income in a future year.
Over-contribution penalty tax – Contributions in excess of a person’s available room are subject to a tax of 1% per month that the excess remains in the RRSP. A lifetime $2,000 over-contribution amount provides relief for inadvertent over-contributions, but there is no deduction allowed when this happens, and if it is deliberate then the penalty tax will still apply.
3. Access before retirement, without triggering tax
Generally – A withdrawal from an RRSP is normally taxable in the year taken. There are two programs that allow non-taxable withdrawals, so long as funds are repaid to the RRSP according to regulated timelines. If repayment is not made, the unrepaid amount is taxable, and no RRSP room is recovered.
Home Buyer’s Plan (HBP) – Qualified first-time homebuyers may each take up to $35,000 to be used toward a home purchase. You must buy or build before October 1st of the year after the year of the withdrawal. Repayment may be spread across 15 years, beginning 2 years after the withdrawal year.
Lifelong Learning Plan (LLP) – You can withdraw up to $$10,000 per year to a maximum of $20,000. Funds must go toward full-time training or education for you or spouse/CLP. Detailed rules determine when you cease to be a student, following which you have 10 years to repay the withdrawal.
4. Taking funds from your RRSP
Cash withdrawal – When you withdraw money from your RRSP, the amount taken is taxable to you in that year. Your RRSP administrator will withhold a percentage for taxes and remit that to CRA: 10% on amounts up to $5,000, 20% from there to $15,000, and 30% on amounts over $15,000.
Tax-free transfers – At any age you may make a tax-free transfer to an annuity or registered retirement investment fund (RRIF). An annuity pays a guaranteed fixed amount for life or a set number of years. A RRIF can be invested like an RRSP, but has a mandatory minimum annual percentage withdrawal. RRIF payments are taxable income, but there is no withholding tax on RRIF minimum payments.
Mandatory maturity – No further contributions may be made after December 31 of the year that the annuitant turns 71. No later than that same December 31 year-end, an RRSP must be matured by one or more of the combination of cash, annuity or RRIF.
Spousal transfers – If your relationship with your spouse/CLP ends, an RRSP may be transferred between you without tax applying. It continues to be an RRSP in the recipient’s hands, subject to tax on eventual withdrawal.
5. Procedure and options on death
Income inclusion – On death, the full amount in the RRSP is treated as taxable income. It is added to all other income earned in the annuitant’s terminal year, which is January 1st to the date of death. This income inclusion applies even if the RRSP assets are directed to a named beneficiary.
Named beneficiary – An annuitant can name a beneficiary to receive the RRSP; otherwise the RRSP administrator will pay the plan proceeds to the estate of the deceased. In the estate, the RRSP assets will be distributed in accordance with the deceased’s Will, or by the rules of intestacy if there is no Will.
Tax-free rollovers – If the named beneficiary is a spouse/CLP, there may be a tax-free rollover to the RRSP of that person. If the RRSP was paid to the estate, there may also be a rollover to a spouse/CLP who has a sufficient financial entitlement as an estate beneficiary. Rollover may also be available to a disabled financially dependent child or grandchild. Limited rollover may be possible if that child is not disabled.