Essentially, in Canada, we have 3 investment vehicles we can use to accumulate our assets/wealth. We can use RRSPs, Open (Non-registered) Plans, and the newly introduced TFSA (Tax-Free Savings Account). Each one of them has their pros and cons and each must be used according to the clients situation and goals.
What is an RRSP?
An RRSP is an investment vehicle that allows Canadians to grow money tax-deferred (this means you don't pay taxes on the money until it is withdrawn). When a person makes a contribution to their plan, they get a tax deduction for the amount that was contributed. This can be a great thing for those who are in higher tax brackets, and can also help them get into a lower tax bracket.
Any income within the RRSP is not taxable while it is still within the plan and grows tax-free until it is withdrawn. The funds can be withdrawn at any time, but not without any consequence. The withdrawn amount gets added to the persons earned income and can potentially put them into a higher tax bracket. There are also taxes that are witheld at time of withdrawal, which is based on the amount withdrawn.
A person can keep funds within an RRSP until the end of the year in which they turn 71, at which point it must be converted into a RRIF (Registered Retirement Income Fund -- something we will discuss at another point).
Why RRSP?
An RRSP can be a great way to invest for your future, if it is done properly. Lets take a look at a few benefits of the RRSP:
- Tax Deduction
- Tax Deferred Growth
- Possibility of putting you in a lower tax bracket
- You can use funds within an RRSP for First Time Home Buyers plan [HBP] (funds must be repayed within 15 years of withdrawal otherwise they are subject to taxation)
- You can set up a Spousal RRSP to split income (which will be discussed in another post)
- Unused contribution gets carried forward
- You can use funds within an RRSP for Lifelong Learning Plan [LLP] (funds must be repayed within 10 years of withdrawal otherwise they are subject to taxation)
- In the event of death, the RRSP can be transferred to a spouse's or a common-law partner's RRSP tax-free
As you can see, the RRSP can offer several benefits to those, IF it is used properly.
Things to be aware of
Even though there are many benefits to an RRSP, there are also many things to be aware of, that most people are not aware of because they are not told. Some of these things include:
- There is contribution limit (based on previous years income as stated on taxes)
- All growth within the RRSP is considered as "interest income" no matter which type of growth it was (capital gains, dividends, or interest). This means when you withdrawal, you will be taxed at your tax bracket and there are no tax benefits for different types of investments
- You will be taxed on the FULL amount of withdrawal, and not just the growth, within the RRSP
- Once you reach age 71, you MUST either a) transfer the funds into a RRIF (which results in forced withdrawal from the RRSP) b) purchase an annuity or c) withdrawal the amount in full
- You can end up paying more money in taxes in your later years if your income is higher; this could negate any tax deductions you had received in previous years; you can possibly pay more money in taxes in retirement then you saved in the earlier years
- There is a limit that you are able to contribute every year; A Tax of 1% per month applies on the portion of your RRSP contribution that exceeds your RRSP deduction limit and the over-contribution limit of $2000
- Interest on funds borrowed to invest into an RRSP are not tax-deductible (as they would if they were invested into an Open [non-RRSP] Investment)
- If funds are not payed within the specified timelines for the Home Buyers Plan and the Lifelong Learning Plan, you will be subject to taxation
Contribution Limit
The maximum RRSP contribution limit 2012 is $22,970. However, if you did not use all of your RRSP contribution limit for the years 1991-2011, you can carry forward the unused amount to 2012. Therefore, your RRSP contribution limit for 2012 may be more than $22,970.The maximum RRSP contribution limit for subsequent years is as follows:
- 2012 maximum RRSP contribution limit: $22,970
- 2011 maximum RRSP contribution limit: $22,450
- 2013 maximum RRSP contribution limit: $23,500 plus inflation index amount
- 2014 maximum RRSP contribution limit: Indexed to inflation
- 2015 maximum RRSP contribution limit: Indexed to inflation
Now, it is evident that there are many things that you should be aware of before using RRSPs as your investment vehicle. Like I said before, they can be a great investment vehicle IF used properly. What I don't like is how they are marketed; they're marketed as the "one size fits all, for everybody, in every situation". The traditional industry (specifically the banks) have done a terrible job in setting up RRSPs and with educating Canadians about all the pros and cons of them.
When using this investment vehicle, do your homework and consult your advisor. Find out everything you think you will need to know about them. I hope this has helped! If you require any more information, please do not hesitate to contact me. Happy investing!
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