RRSP: An Essential Tool for Tax Planning
  • Personal Finance Planning

What most of us know is that a Registered Retirement Savings Plan (RRSP) is a government-approved plan to encourage Canadians to save for their retirement.

What most of us do not know is that RRSP can also be used as an important tax planning tool.

The primary advantage of an RRSP is that your contribution (within limits) is deductible from your taxable income. This means that you do not pay tax on your contributed income, neither do you pay tax on the income earned through RRSP while the funds are in the plan. 

Who can contribute to an RRSP in Canada?

Generally, you are eligible to contribute to an RRSP if:

  • You have ‘earned income’ and file taxes in Canada.
  • You are under the age of 71 years.

How much can I contribute to an RRSP? 

The RRSP contribution limit varies from year to year. As for 2021, individuals under the age of 71 years can contribute the lesser of the following: 

  • 18% of your earned income in 2020
  • The annual RRSP limit i.e., $27,230 (for 2020)

When is the RRSP deadline for 2021?

The deadline for contributing to an RRSP for the 2020 tax year is March 1, 2021.

How do I set up an RRSP?

Once you know your RRSP deduction limit, setting up an RRSP account is fairly simple and requires the following steps:

  • Speak to your financial institution/ financial advisor.
  • Understand your RRSP contribution limit and the RRSP deadline.
  • Apply online with your financial institution and set up your RRSP account.
  • Enjoy watching your savings grow and your taxes reduce.

What are the benefits of an RRSP?

Apart from helping you build savings for your retirement, an RRSP can help substantially reduce your tax implications and even help you buy your first home! 

The various benefits of an RRSP are as below:

  • You can claim your RRSP contribution as a deduction on your gross income, thereby reducing your taxable income. The example below will help you understand this better:

Since you do not pay tax on your earnings until they are in the plan, an RRSP helps you grow your savings tax free.

  • You can borrow from your RRSP account to buy your first home in Canada. The Home Buyer’s Plan allows you to borrow up to $35,000 from your RRSP savings to use towards the down payment of your home. To qualify for the home buyers plan, you must ensure that the RRSP funds you are using have been in deposit for a minimum of 90 days. The withdrawal is non-taxable as long as you repay it within 15 years. 
  • You can also borrow from your RRSP account to finance your education. The Lifelong Learning Plan allows you to borrow up to $10,000 for full-time training or education for yourself, your spouse, or common-law partner. Again, to qualify for the Lifelong Learning Plan, you must ensure that the RRSP funds have been in deposit for more than 90 days. The withdrawal is non-taxable if you repay it within 10 years. 

  • You can also convert your RRSP account into a Registered Retirement Income Fund (RRIF) when you retire. You will then receive regular payments each year and pay tax on those receipts. However, post-retirement you will most likely be in a lower tax bracket and thus pay lesser tax as opposed to withdrawing it early on. 

  • If you earn higher than your spouse, you can also opt for spousal RRSP which allows you to contribute towards the RRSP account of your spouse. This will reduce your RRSP contribution limit, but on retirement, there will be two smaller incomes instead of one big income which will then help you save on taxes as a couple. 

Is RRSP better or TFSA?

While a Tax-Free Savings Account (TFSA) is not specifically designed as a retirement savings account, it can be an excellent accompaniment to an RRSP. While both these tools will help you build savings and save on taxes, they both work differently.

An RRSP helps deduct your taxable income based on the amount you contribute towards your RRSP account while a TFSA involves paying taxes before you contribute. RRSP does not involve any tax payments until you withdraw, whereas TFSA has tax-free withdrawals of your gains.

Simply put, an RRSP allows you to defer your taxes while you save for retirement while a TFSA allows you to grow your savings through eligible investments.

Both RRSP and TFSA are effective tools for tax planning. Your current financial situation and future financial goals will help you decide which (or both) work better for you.

Now that you know more about RRSP and its tax implications, take charge of your investments and speak with your financial advisor today. A little planning can help save you hundreds of dollars that you can then use towards achieving your goals!

* Life Simpli and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.