Everything you need to know about RRSPs, and more!
A RRSP (Registered Retirement Savings Plan) is a type of Canadian retirement savings account that allows you to set aside money for your retirement and receive tax benefits for doing so.
The deadline to contribute to your RRSP for the 2022 tax year is March 1, 2023.
In this blog we will be covering the most common questions about the RRSP, to help you prepare for the rapidly approaching deadline.
- How does it work?
- What’s the benefit?
- How much can you put into your RRSP?
- What they don’t tell you
- And 4 things we see people get wrong all the time
How does an RRSP work?
An RRSP is set up to be your retirement savings if you earn an income in Canada. The main benefit is that any money you put into your RRSP will reduce your taxable income by that amount – up to a limit.
For example, if you earn $100 thousand dollars and you put $20 thousand into an RRSP, your taxable income for that year will be $80 thousand. So you pay income tax on the lower $80 thousand instead of paying tax on the higher $100 thousand.
On the flip side, any money you take out of your RRSP is added to your taxable income for that year. For example if you earn $100 thousand dollars and you take $20 thousand out of your RRSP, your income for that year will be $120 thousand.
To find out what your limit is, go to your my CRA website. When you login there’s a section for your RRSP and TFSA contribution room. That’s your limit. It will be different for everyone depending on your age, income and how much you’ve contributed to your RRSP in the past.
Another big benefit of investing in your RRSP is that the growth inside is tax deferred until you take it out. This helps accelerate your wealth creation because your growth is not eroded by taxes every year and it has time to compound over the years.
What they don’t tell you
The government, the media and the big financial institutions pump RRSP like everybody should do them and that’s not always the case.
RRSPs are great for employees who don’t have any other ways to defer tax on their income. If you receive a T4 from your employer – which is the majority of people – then RRSP is one of the few things you can do to save on your income tax.
But business owners have their company or holding company to store money for the long term. It generally doesn’t make sense for a profitable business owner to put money into their RRSP – and you’re not going to see a single ad from a bank or investment company telling you this.
Why doesn’t it make sense for business owners to put money into their RRSP?
Well, keeping your money in your corporation, you pay the corporate tax rate, which here in BC is 12%. Why would you pay yourself the extra money as income to get a limited tax deduction if you could just leave the money in your corporation and do nothing and come out ahead?
Then when you leave the money in your corporation, there’s other things we can do to help you grow that money in a tax advantaged way.
What people do wrong – here are 4 things
First – not investing the money.
I see this all the time and it’s crazy! An RRSP (and a TFSA) are investment accounts. However, I often see people’s statements and they have an RRSP or TFSA account but the money is not invested.
It’s just sitting there in cash which defeats the whole advantage of the tax deferred (or tax free in your TFSA) growth.
If you have money in your RRSP make sure it’s invested. I mean it’s nuts not to. You can put it into all sorts of things like stocks, bonds, mutual funds, segregated funds and tons of other stuff.
Second — is that mainstream information doesn’t tell you is that you can take the money out of your RRSP anytime you want.
All the ads and the general information always talks about taking out your RRSP money during retirement – which is the main reason for having an RRSP in the first place.
But another great time to withdraw from your RRSP is in a year where you are going to have lower income. For example, you’re not employed right now because you’re working on a new company and you’re not earning a lot of money yet. This is a great time to draw from your RRSP because the increase in income won’t hit you too hard with taxes.
Or if you’re taking a sabbatical and travelling the world or going back to school and won’t earn anything this year – great time to take from your RRSP.
Generally in low income years is when you want to withdraw from your RRSP.
It kills me that people don’t tell you that.
Another time you can take from your RRSP before retirement is for the First Time Homebuyers Program you can withdraw up to $35 thousand dollars to buy a house. You have to repay this money over the next 15 years or it will be taxed, but it’s a great program to take advantage of.
You can also take up to $20 thousand under the lifelong learning program to go back to school. This needs to be put back into your RRSP as well or you will be taxed on the amount you withdrew.
This third one is an expensive mistake. We’re actually dealing with 2 of these right now. The mistake is people having too much money in their RRSP
We’re not talking about over-contributing past your limit. What we’re talking about is when you come to retirement age and you literally have too much money in your RRSP and you don’t need it all. It is very expensive in tax to take it out.
Here’s an example – we’re working with a very successful realtor of 40 years. She wants to retire in the next couple of year – she probably won’t all the way retire, but she wants to slow down a lot.
Her situation is that in the 40 years of being a realtor she has bought rental properties along the way and currently makes about $25 thousand per month from her rentals. She could stay in bed all day and this $25 thousand is going to come in every month regardless of what she does.
She’s also still working and consistently makes between $400 – $600 thousand a year. She’s living a great and blessed life and she’s an awesome lady.
Here’s the catch – when she was younger, she “did what you’re supposed to do” and put money into her RRSP. Today she has about $1 million dollars in there. Sounds great.
She’s in her mid 60s right now and doesn’t need to use any of the money in her RRSP. If she takes it out now about 50% is gone to taxes.
Even if she leaves it in there, when she turns 71, she’s forced to terminate the RRSP and either cash it out, buy an annuity or convert it to a RRIF. In all of these cases, she’s going to be forced to take the money out of her RRSP and it’s going to be a big taxable event.
This is a case of someone who shouldn’t have put money into her RRSP, but she did what we’re all told we’re supposed to do.
So if you’re making a lot of money now, and you’re going to keep making a lot of money later, then be very strategic about your RRSP contributions – don’t just blindly put in the maximum every year because you might get stuck with trapped money and a big tax bill in the future.
Talk to someone and plan it out and see if it’s worth it for you to do.
The 4th thing that a lot of people get wrong about RRSP is they think that there’s a penalty for withdrawing outside of retirement.
There isn’t a penalty for withdrawing from your RRSP. You can withdraw anytime you want. You would just have to pay tax on that.
There’s no penalty, you just have to pay the tax that you didn’t pay before.
So that’s it, answers to some RRSP questions that aren’t the Top 10 RRSP questions that anyone could just Google.
These are some things that we see from experience with clients and that aren’t mainstream knowledge found on the hundreds of personal finance blogs, bank brochures and YouTube channels.
There are pros and cons to RRSPs like with any other financial account type. There’s good and there’s bad. Do what’s right for your personal life situation.
Reminder that the deadline for contributing to your RRSP for this year is March 1st, 2023. Please don’t call us or your investment person 2 days before March 1st to get this done because we will hate you. We’ll probably get it done anyways, but it’s way easier if you call now and we have plenty of time to get the paperwork done and transfer money around to where it’s supposed to go.
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