RRSP – Registered retirement savings plan

Tax-deferral that lays the foundation for a secure retirement

The registered retirement savings plan is designed to assist with long-term savings, generally funding toward your retirement years.

Qualified investments for RRSPs include deposits, guaranteed investment certificates, stocks, bonds, mutual funds and segregated funds. As the owner of the plan, you are known as the annuitant.

Here are some important facts about RRSPs.

What are the key tax features?

A number of tax features come into effect when your retirement savings are ‘registered’ for tax purposes.

- RRSP contributions are tax-deductible in the year for/in which they are made
- Income within the RRSP is not taxed in intervening years, deferring tax until withdrawal
- Withdrawals are taxed in the year taken, leading to lower tax if you are at a lower bracket at that time

How much can you put into your RRSP, and when?

Annual contribution room is 18% of the previous year’s earned income, to an indexed dollar maximum.

- For the 2024 tax year, the dollar maximum is $31,560, reached at 18% of 2023 income of $175,333
- If you over-contribute, a 1% per month penalty applies to the excess while it remains in the RRSP
- Unused room may be carried forward to use in future years, up to the end of the year you turn 71
- To claim a deduction, contributions must be made in the year, or within 60 days after year-end
- You may contribute to your own RRSP, or to a spousal RRSP of a spouse/common law partner (CLP)

Can you access the funds in your RRSP without triggering tax?

You may borrow from your RRSP, but if you don’t repay on time, any unrepaid amount becomes taxable.

Home Buyer’s Plan (HBP)

Qualified first-time homebuyers may each take up to $60,000 for a home purchase. (This figure was raised in the 2024 Federal Budget from $35,000.) Repayment is required over 15 years, beginning the 2nd year after the withdrawal year.

Lifelong Learning Plan (LLP)

You may withdraw up to $10,000 per year to a maximum of $20,000. Repayment is over 10 years, starting the 2nd year after ceasing to be a student or the 5th year after withdrawal

How do you draw from your RRSP to fund your retirement spending?

There is no minimum age to begin withdrawing from your RRSP, but it can’t be later than the end of the year you turn 71, and no contributions are allowed to your RRSP after that date. There are three ways to draw down your RRSP.

Cash-in your RRSP

The entire cashed-in amount will be taxable that year, which could push you up into higher tax brackets, so this is not usually desirable except for a small RRSP

Purchase an annuity

Annuities pay a guaranteed fixed amount for life or a set number of years. Payments are often made monthly, with the total annual receipts taxable each year

Transfer to RRIF

You must take a minimum amount out of a RRIF each year (except the first/transfer year), although you can take more. Amounts taken are taxable each year

What happens if you die?

The default treatment on death is for the RRSP to be paid to the annuitant’s estate and included as taxable income in the annuitant’s terminal year, January 1st to the date of death. Simple steps to avoid this result:

Designated beneficiary on the plan

An annuitant can name a beneficiary to receive the RRSP directly, rather than it falling into the estate. The income inclusion still applies unless a rollover is available

Rollovers

If you name a spouse/CLP, financially dependent minor child/grandchild, or financially dependent disabled child/grandchild, the plan may roll tax-deferred to the recipient’s registered plan

Smart use of RRSP loans

The payback sets you up for the payoff*

Saving for retirement is an important habit to cultivate. We hear about this a lot in January and February each year, as deposits to a registered retirement savings plan (RRSP) in the first 60 days of the year can be claimed as a deduction from the preceding year’s income.

But what if you don’t have the cash readily available to sock into your RRSP? One option is to borrow money for the purpose, using what is known as an RRSP loan. In doing so, keep in mind that this is not intended to be a permanent arrangement, but rather a temporary time-shifting tool. As with any loan, it is important to plan for how and when that loan will be repaid.

To appreciate why early repayment of the loan is so critical, the starting point is to understand how interest on an RRSP loan is treated.

Implications of non-deductible interest

If you borrow money to invest to produce taxable income, your interest cost is generally tax-deductible. However, when a loan is used to make an RRSP contribution, interest is not deductible. While at first this may seem unfair, remember that income and growth within an RRSP are not subject to tax. Thus there is an element of symmetry in this comparison:

- Deductibility with taxable income
- Non-deductibility with tax-exempt income

That’s not the end of the story though, as RRSP money will eventually be taxed when it is drawn out of the plan. The combination of non-deductible interest with eventual taxable income should serve as reinforcement to repay an RRSP loan in a timely manner.

How timely? Let’s look at some numbers to help show the cost of that non-deductible interest.

The cost of RRSP loan retirement

For RRSP loan interest, you must first earn income and pay tax on it, and then use what’s left over to pay the interest. To illustrate, we’ll assume a $60,000 income where the marginal tax rate is about 33% (allowing that some provinces are a little higher and others a bit lower). That means $1.50 in pre-tax income would be needed to pay 50 cents of tax, and end up with $1 to make that interest payment.

As a counterpoint, RRSP loans can usually be arranged on more favourable terms than other loans. While it is illegal for a financial insitution to compel you as a borrower to use the loan proceeds to invest with it, the lender is allowed to offer a better rate on the loan if you decide to do so.

But even with favourable rates, don’t forget that the principal will eventually need to be returned to the lender, in addition to interest payments in the meantime. Just as the interest is not tax-deductible, neither is the principal repayment. As well, keep in mind that the tax issues have no effect on your legal obligation to repay the loan, even if the investment decreases in value.

When taking out the loan then, you should already be thinking about how and when you are able to pay it back.

Repayment timeline

Continuing our 33% tax rate example, if the loan is used to make a $6,000 RRSP contribution, it would generate a $2,000 refund. Unless a real emergency occurs between the contribution date and receivng the refund, an immediate paydown of the loan should be the first and only priority for that refund, leaving a $4,000 balance.

According to the Canada Revenue Agency (CRA), you can expect that refund within two weeks if you file online, or up to eight weeks for paper returns. So this year if you file by due date at the end of April, you can have your refund by mid-May. That gives you almost eight months to pay off the remaining $4000 loan (or a little over $500 per month including interest) before the end of the year.

But of course an earlier filing means an earlier refund and an earlier start on those repayments, so if you’re really keen, CRA begins accepting returns as early as the end of February. The reason it is so important to retire the loan by the end of the year is that if payments continue into the following year, there will be less cash available to make the next round of RRSP contributions, whether or not loans are involved.

If that repayment schedule feels unmanageable, perhaps the amount of the RRSP loan should be reconsidered. One approach would be to begin by deciding how much of your monthly cash flow you can comfortably commit to repayments, and let that guide you on the size of loan you can handle.

Strategically getting ahead on your savings

If you are successful in retiring the loan before the end of the year, you can realllocate the monthly cash flow you used for repayment, directly into your RRSP. Whether that’s a few weeks early or a few months, you are paying yourself back with three key benefits:

- First, the earlier the loan is retired, the lower the total interest you will pay.
- Second, those new RRSP contributions will be deductible, whereas the interest and principal repayments on your RRSP loan were not.
- Third, having already begun your RRSP contributions during the year, you won’t need as large an RRSP loan when you come to next year’s first 60 day period. By using this kind of strategic approach, you can progressively wean off of RRSP loans entirely in just a few years, putting your RRSP savings routine on a more stable and sustainable course.

Your financial advisor can help you determine where you are at with your savings presently, whether an RRSP loan fits your needs, and how to manage it so you get the optimal tax benefits from your RRSP savings.

—————

* Using borrowed money to finance the purchase of securities involves greater risk than purchasing using cash resources only. If you borrow money to purchase securities, your responsibility to repay the loan and pay interest as required by its terms remains the same even if the value of the securities purchased declines.

Five tax drivers of RRSPs

Taking full advantage of registered plan features

A registered retirement savings plan (RRSP) helps you save towards retirement in a tax-effective way. Through five key features, an RRSP encourages you to save, lets you defer tax so you can accumulate more, and paves the way for you to ultimately reduce tax on your retirement income.

1. Tax-deductible contributions

For every dollar you place into an RRSP, you can take a deduction against your income.

In a sense you are declining to receive that income in the current year, in favour of taking it as income some time later. Though that income is yours to keep, you are setting it aside in an RRSP where it can be invested until you draw on it, generally meaning your retirement.

There are limits to how much deduction can be taken, based on historical income and past contributions, but it’s the mechanics of the procedure we’re focused on presently.

2. Investing pre-tax dollars

Had you not made an RRSP contribution, you would have been taxed on that amount. That would have left you with less money to be invested in your hands directly as compared what you have available in your RRSP. Put another way, you are investing pre-tax dollars as opposed to after-tax dollars.

We’ll discuss the tax applying on RRSP withdrawals below, but for now the result is that there is more available to earn investment income.

3. Tax-sheltered earnings and growth

With the benefit of those larger pre-tax dollars, the next step in using an RRSP is to start investing your money. As those investments grow and earn income, there is no tax to be paid, or as is commonly stated, an RRSP is ‘tax-sheltered’.

Some people prefer the term ‘tax-deferred’, given that eventual withdrawals are taxable, as we’ll cover in a moment. Until withdrawal though, there is more to be reinvested, which leads into the next feature – compounding.

4. Tax-efficient reinvestment and compounding

Just as using pre-tax money gives you more to start with, reinvesting tax-sheltered income can accelerate your growth. This is obviously helpful at first instance, and gets even better over time through the effect of compounding.

Initially only your own principal is being invested, but as you earn income then that income is invested, which generates income-on-income. Year after year, this repeated reinvestment is responsible for an increasing portion of your returns, in time possibly exceeding what you earn on your own contributions.

This compounding effect is not at all exclusive to RRSPs, but it will be accentuated in an RRSP where the full amount of all earnings can be put to work without being reduced by taxes.

5. Tax deferral until withdrawal, likely at lower tax bracket

The features covered to this point have helped you build your investments with the benefit of tax deferral on both contributions and earnings. Now on withdrawal, tax is due. Even so, you will pay less tax by using an RRSP, assuming your tax rate is lower on withdrawal in your later years than it was on contribution in your working years when you contributed.

But what if you are early in your career at a fairly low-income level? Most people will make the RRSP contribution and claim the deduction. That’s a smart savings habit, but you can also be strategic with the taxes. Instead of taking the deduction that same year, you can carry it forward to claim in a year when you’re at a higher tax bracket, making the deduction worth more.

Your financial advisor can help you decide whether deferring the deduction makes sense for you, and how you can take best advantage of all the tax features of RRSPs.