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A Registered Retirement Savings Plan (RRSP) is an investment account designed to help you prepare for retirement by maximizing your savings income and providing tax shelter.
Here are the main benefits of an RRSP
Contributions are tax-deductible
You can use both pre-tax dollars, if you employer allow it, or after-tax dollars to contribute to your RRSP. Using pre-tax dollars postpones your tax liability to the following tax year. Any after-tax contributions you make are deducted from that year’s income. For example, if you make $80,000 a year and put $10,000 (after-tax) into an RRSP, you will be taxed as though you make $70,000.
Some withdrawals can be made without paying tax
- First time home buyers can withdraw funds tax-free with the Home Buyers Plan (HBP)
- People returning to school can use the Life Long Learning Program (LLP)
Both of these programs have limits on how much money you can withdraw and require you to pay the funds back to your RRSP over time to avoid paying taxes on those funds.
Withdraw your funds at any age
You can withdraw money from your RRSP at any time there are a few caveats, however. You will have to pay taxon the money you withdraw, and you won’t be able to put the money back later. You will be charged a withholding tax on the amount of withdrawal, at a rate depending on the withdrawal amount. Contribution allotments can only be used once, so unlike a TFSA, if you withdraw the money, you can’t replace the funds later. During the year you turn 71, funds in the RRSP must be withdrawn, or transferred to a Registered Retirement Income Fund (RRIF) or annuity.
Efficient, tax-sheltered investments and compounding
Funds deposited in an RRSP are invested directly by you or by the person/organization managing the plan. Income from those investments stays in the fund and is then re-invested – compounding your return. Essentially you are earning income-on-income and increasing your savings without necessarily contributing more money. Again, no tax is owed on this income until you withdraw the money from your RRSP.
Defer taxes until your money is withdrawn
The idea here is that when you retire and withdraw the money from your RRSP, you will be in a lower tax bracket than you were when you deposited the funds, and therefore, pay less tax. It’s important to consider that when you are making RRSP contributions. If you’re early in your career with a modest income, you could consider saving using a TFSA until your income allows you to maximize this benefit.
Have more questions about RRSP’s? We can help. Contact an advisor today.