You’re probably familiar with the basics of Registered Retirement Savings Plans (RRSPs), including how they can help you pay less tax now and secure your future. But to know if an RRSP is the right place to stash your hard-earned retirement savings, it helps to dig a little deeper. Here are some important factors to consider before you open an RRSP.
The RRSP deadline is marked for 60 days past December 31 of each tax year. The last day you can make an RRSP contribution to reduce your tax bill for the previous year is on March 1 (or February 29 during a leap year).
If you’re like many investors, the most advantageous strategy is to “max out” your allowable contribution limit prior to the RRSP contribution deadline. That way, when you convert your RRSP into retirement income – mandatory the year you turn 71 – you can access it at a lower tax rate, when you’re past your prime income-earning years.
RRSP contribution limit
For the 2023 tax year, Canadians can save 18% of their income in an RRSP, up to a maximum of $30,780. But you may be eligible to save even more! Here’s why.
Everyone has a different annual RRSP contribution limit, because unused RRSP contribution room is carried forward from year to year. Therefore, your RRSP limit is adjusted annually, based on changing income and the accumulation of unused room. This lets you maximize savings and tax breaks throughout your earning years. To find out your individual RRSP contribution limit for the current year, check your most recent Notice of Assessment from Canada Revenue Agency (CRA).
At its core, RRSP investing makes sense for those wanting to reduce their annual income-tax bill, while letting their money compound over the long term. But, if you’re in a low tax bracket – maybe you’re just starting your career or working part-time? – a TFSA may provide you with more immediate tax benefits.
How can you come up with money at RRSP time?
There are several strategies for saving within an RRSP. Some people save throughout the year (or save last year’s tax refund) and contribute a lump sum of money. Many more people contribute regular monthly amounts; not only is it easier to budget, but it can also increase the value of the investment faster. That’s because every small amount has longer to compound.
RRSP withdrawal rules
December 31 of the year you turn 71 is the last day you can make an RRSP contribution. At this point, RRSP withdrawal rules at age 71 require you to choose one of the following options:
- Withdraw the funds in a single lump sum: Want all of your money right away, so you can buy that car, take that dream vacation, and spend as you see fit throughout retirement? Be extremely careful. In most cases, this option results in the largest tax bill. Since the entire RRSP withdrawal will count toward your taxable income for that year alone, you could lose a large portion of your savings.
- Use the funds to purchase an annuity: If you’re concerned about outliving your money, an annuity may ease your mind. It uses your RRSP savings to provide a guaranteed income for the rest of your life. You don’t pay any tax when you use your RRSP funds to purchase an annuity, but the regular annuity payments you receive are taxable as income.
- Transfer the funds to a RRIF: A Registered Retirement Income Fund (RRIF) functions much like an RRSP. It can hold segregated funds and mutual funds, and other types of investments. Like RRSPs, you don’t pay any tax on your investment growth. While your money can still grow, you must withdraw a minimum amount each year, which is considered taxable income.
In actual fact, you can convert an RRSP to an annuity or a RRIF and begin withdrawing funds at any age prior to 71. Otherwise, if you make an RRSP withdrawal prior to converting it to a RRIF or annuity, your funds will be subject to tax at your current tax rate; you will also lose that contribution room within your RRSP.
The only exceptions to this rule are if you’re using the funds to purchase or build your first home or continue your education. In that case, it also helps to be aware of this: Taking $10,000 from a $100,000/6%-earning RRSP could mean $56,000 less over 20 years – roughly the amount of time you’ll be given to pay that money back.
While we’re talking about RRIFs, here’s a rough guide to making withdrawals from your RRIF.
Withdrawing from your RRIF
Beginning the year after you set up your RRIF, the government requires you to withdraw a minimum amount of your savings each year. At age 65, that amount is 4% of the account’s value. These rates rise slightly every year, topping out at 20% for those 95 and older. So, if your RRIF has a value of $500,000 at age 71, with a minimum withdrawal amount of 5.28%, you must take out $26,400 that year.
There is no maximum RRIF withdrawal amount. But keep in mind that the more you take out in one year, the more tax you’ll pay that year.
To be clear, RRSPs offer tax-deferred (not tax-free) savings, which means you don’t pay income tax on the funds until they’re withdrawn in retirement. Therefore, you’ll pay tax on the amount of money you take out of your RRIF annually, but you’ll likely be in a lower tax bracket at that time.
Spousal RRSP contributions
A spousal RRSP allows one spouse to make use of their personal RRSP contribution room and the corresponding tax deduction, while investing in their spouse’s name.
This allows couples with a large income disparity to lighten the tax load on the higher-income earner – something called “income splitting.” The higher-income earner will benefit from the immediate tax break provided by the RRSP contribution. When the money is withdrawn in retirement, it is taxed in the hands of the lower-income earner (the spouse), resulting in an overall reduction in the amount of tax paid. Keep in mind that the amount you collectively contribute to your own RRSP and a spousal RRSP must fall within your individual RRSP contribution limit.
When deciding whether or not to contribute to a spousal RRSP, it’s important to consider what your partner’s income will look like in retirement. If you believe that you will accumulate more retirement assets than your partner (for example, you believe you will have a larger pension), contributing to a spousal RRSP may reduce your family’s total tax bill.
Spousal RRSP withdrawal rules
Just like RRSPs, spousal RRSP withdrawal rules stipulate tax penalties for accessing the funds early. Namely, any withdrawals within three years of a contribution from a spouse will count toward the contributor’s taxable income.
In retirement, you can take advantage of spousal RRIFs (converted from a spousal RRSP), which will reduce the overall tax you pay as a couple. Here’s an example of how a couple withdrawing a combined total of $12,000.00 ($1000/month) per year from their RRIFs can reduce their tax bill.
|Scenario 1||Tax Bracket||Tax Paid|
|High income earner withdraws all $12,000 from their RRIF||40%||$4,800|
|Scenario 2||Tax Bracket||Tax Paid|
|High income earner withdraws $6,000 from their RRIF||40%||$2,400|
|Lower income earner withdraws $6,000 from their RRIF||20%||$1,200|
“Income splitting” is still an option, too, with spousal RRIFs. You can move a portion of retirement-income withdrawals to your spouse. Likewise, you can transfer up to 50% of your pension to your partner, from sources like RRSPs, RRIFs and annuities (but not from the Canada Pension Plan or Old Age Security).
In situations where an age difference exists between you and your partner, simply calculate your minimum withdrawal amount, based on the age of the youngest partner. This leaves more tax-sheltered money in your account(s) to grow. Which, ultimately, can help you make your funds last longer.
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*In the province of Quebec, the authorized representatives are Financial Security Advisors who have been duly certified by the Autorité des marchés financiers. The information contained in this report was obtained from sources believed to be reliable; however, we cannot guarantee that it is accurate or complete and it should not be considered personal taxation advice. We are not tax advisors and we recommend that clients seek independent advice from a professional tax advisor on tax related matters. Mutual funds are offered through Co-operators Financial Investment Services Inc. to Canadian residents except those in Quebec and the territories. Segregated funds and annuities are administered by Co-operators Life Insurance Company. Co-operators Life Insurance Company and Co-operators Financial Investment Services Inc. are committed to protecting the privacy, confidentiality, accuracy and security of the personal information that we collect, use, retain and disclose in the course of conducting our business. Visit www.cooperators.ca/en/Privacy for more information. Co-operators® is a registered trademark of The Co-operators Group Limited.